Table of Contents


 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q 

(Mark One)One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 20182019

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____________ to _____________

 

Commission File Number: 001-34527

 

EMCLAIRE FINANCIAL CORP

(Exact name of registrant as specified in its charter)

 

Pennsylvania

25-1606091

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)

 

 

612 Main Street, Emlenton, Pennsylvania

16373

(Address of principal executive offices)

(Zip Code)

 

(844) 767-2311

(Registrant’s telephone number)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $1.25 per share

EMCF

NASDAQ Capital Market (NASDAQ)

(Title of Class)

(Trading Symbol)

(Name of exchange on which registered)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐                Accelerated filer ☐                      Non-accelerated filer ☐

Smaller reporting company ☒        Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ☐ No ☒

 

The number of shares outstanding of the Registrant’s common stock was 2,690,3122,698,712 at November 8, 2018.2019.

 


 

 

 

EMCLAIRE FINANCIAL CORP

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

  

PART I – FINANCIAL INFORMATION

 

 

 

Item 1.

Interim Financial Statements (Unaudited)

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 20182019 and December 31, 20172018

1

 

 

 

 

Consolidated Statements of Net Income for the three and nine months ended September 30, 20182019 and 20172018

2

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 20182019 and 20172018

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 20182019 and 20172018

4

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 20182019 and 20172018

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

31

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

4239

 

 

 

Item 4.

Controls and Procedures

4239

 

 

 

PART II – OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

4340

 

 

 

Item 1A.

Risk Factors

4340

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

4340

 

 

 

Item 3.

Defaults Upon Senior Securities

4340

 

 

 

Item 4.

Mine Safety Disclosures

4340

 

 

 

Item 5.

Other Information

4340

 

 

 

Item 6.

Exhibits

4340

 

 

 

Signatures

4441

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Interim Financial Statements

 

Emclaire Financial Corp

Consolidated Balance Sheets (Unaudited)

As of September 30, 2018 and December 31, 2017

(Dollar amounts in thousands, except share and per share data)

Emclaire Financial Corp
Consolidated Balance Sheets (Unaudited)
As of September 30, 2019 and December 31, 2018
(Dollar amounts in thousands, except share and per share data)

 

 

September 30,

 

December 31,

 

2018

 

2017

 

September 30, 2019

 

December 31, 2018

Assets

              

Cash and due from banks

 $2,776 $3,072 $3,742  $3,623 

Interest earning deposits with banks

  19,904  11,302  45,560   7,332 

Cash and cash equivalents

  22,680  14,374  49,302   10,955 

Securities-available for sale

  97,509  99,350

Securities-equity investments

  473  1,817

Interest earning time deposits

  10,198   6,738 

Securities - available-for-sale

  117,899   97,718 

Securities - equity investments

  23   7 

Loans held for sale

  120  504  154    

Loans receivable, net of allowance for loan losses of $6,360 and $6,127

  592,125  577,234

Loans receivable, net of allowance for loan losses of $6,509 and $6,508

  688,357   708,664 

Federal bank stocks, at cost

  4,466  4,662  5,856   6,351 

Bank-owned life insurance

  11,974  11,724  15,194   14,881 

Accrued interest receivable

  2,302  2,217  2,754   2,570 

Premises and equipment, net

  17,722  18,010  20,685   18,911 

Goodwill

  10,288  10,288  19,460   19,448 

Core deposit intangible, net

  278  481  1,289   1,423 

Prepaid expenses and other assets

  12,867  9,423  10,259   11,209 

Total Assets

 $772,804 $750,084 $941,430  $898,875 

Liabilities and Stockholders' Equity

              

Liabilities:

              

Deposits:

              

Non-interest bearing

 $133,311 $126,263 $155,923  $148,893 

Interest bearing

  549,050  528,380  652,102   612,653 

Total deposits

  682,361  654,643  808,025   761,546 
Short-term borrowed funds  2,050  2,500  2,050   12,850 

Long-term borrowed funds

  17,750  23,500  31,750   32,500 

Accrued interest payable

  460  413  652   495 

Accrued expenses and other liabilities

  10,573  9,937  13,022   11,476 

Total Liabilities

  713,194  690,993  855,499   818,867 

Commitments and Contingent Liabilities

  -  -      

Stockholders' Equity:

              

Common stock, $1.25 par value, 12,000,000 shares authorized; 2,373,156 and 2,373,156 shares issued; 2,271,139 and 2,271,139 shares outstanding, respectively

  2,966  2,966

Preferred stock, $1.00 par value, 3,000,000 shares authorized; Series C, non-cumulative preferred stock, $2.9 million liquidation value, 286,888 shares issued and outstanding; Series D, non-cumulative preferred stock, $1.3 million liquidation value, 133,705 shares issued and outstanding

  4,206   4,206 

Common stock, $1.25 par value, 12,000,000 shares authorized; 2,800,729 shares issued; 2,698,712 shares outstanding

  3,501   3,501 

Additional paid-in capital

  31,218  31,031  46,672   46,401 

Treasury stock, at cost; 102,017 shares

  (2,114)  (2,114)  (2,114)  (2,114)

Retained earnings

  34,940  32,726  38,142   34,371 

Accumulated other comprehensive loss

  (7,400)  (5,518)  (4,476)  (6,357)

Total Stockholders' Equity

  59,610  59,091  85,931   80,008 

Total Liabilities and Stockholders' Equity

 $772,804 $750,084 $941,430  $898,875 

 

See accompanying notes to consolidated financial statements.

 

1

Table of Contents

 

 

Emclaire Financial Corp

Consolidated Statements of Net Income (Unaudited)

For the three and nine months ended September 30, 2018 and 2017

(Dollar amounts in thousands, except share and per share data) 

Emclaire Financial Corp
Consolidated Statements of Net Income (Unaudited)
For the three and nine months ended September 30, 2019 and 2018
(Dollar amounts in thousands, except share and per share data) 

 

 

For the three months ended

 

For the nine months ended

 

September 30,

 

September 30,

 For the Three Months Ended September 30, For the Nine Months Ended September 30,
 

2018

 

2017

 

2018

 

2017

 

2019

 

2018

 

2019

 

2018

Interest and dividend income:

                            

Loans receivable, including fees

 $6,688 $5,966 $19,703 $17,333 $8,170  $6,688  $24,514  $19,703 

Securities:

                            

Taxable

  464  421  1,312  1,208  583   464   1,606   1,312 

Exempt from federal income tax

  137  134  430  418  79   137   301   430 

Federal bank stocks

  65  64  221  179  104   65   316   221 

Interest earning deposits with banks

  112  98  228  151  251   112   397   228 

Total interest and dividend income

  7,466  6,683  21,894  19,289  9,187   7,466   27,134   21,894 

Interest expense:

                            

Deposits

  1,183  824  3,277  2,276  1,938   1,183   5,045   3,277 

Borrowed funds

  142  322  440  954  233   142   769   440 

Total interest expense

  1,325  1,146  3,717  3,230  2,171   1,325   5,814   3,717 

Net interest income

  6,141  5,537  18,177  16,059  7,016   6,141   21,320   18,177 

Provision for loan losses

  300  270  980  633

Provision for (recovery of) loan losses

  (145)  300   305   980 

Net interest income after provision for loan losses

  5,841  5,267  17,197  15,426  7,161   5,841   21,015   17,197 

Noninterest income:

                            

Fees and service charges

  528  448  1,428  1,290  531   528   1,622   1,428 

Net gain (loss) on sales of securities

  (4)  -  (34)  350

Net realized gain (loss) on sales of securities

  42   (2)  43   (9)

Net gain on sales of loans

  35  46  60  176  77   35   129   60 

Other than temporary impairment losses

  -  -  -  (508)

Earnings on bank-owned life insurance

  105  103  311  305  96   105   313   311 

Gain on bargain purchase

  -  1,307  -  1,307

Other

  398  370  1,244  1,076  463   396   1,289   1,219 

Total noninterest income

  1,062  2,274  3,009  3,996  1,209   1,062   3,396   3,009 

Noninterest expense:

                            

Compensation and employee benefits

  2,519  2,288  7,493  6,957  3,187   2,519   8,892   7,493 

Premises and equipment

  736  718  2,264  2,203  810   736   2,536   2,264 

Intangible asset amortization

  67  58  203  177  44   67   134   203 

Professional fees

  243  157  712  575  278   243   664   712 

Federal deposit insurance

  103  115  391  325     103   267   391 

Acquisition costs

  677  963  1,036  1,069     677      1,036 

Other

  1,210  1,143  3,437  3,434  1,439   1,210   4,155   3,437 

Total noninterest expense

  5,555  5,442  15,536  14,740  5,758   5,555   16,648   15,536 

Income before provision for income taxes

  1,348  2,099  4,670  4,682  2,612   1,348   7,763   4,670 

Provision for income taxes

  187  392  735  978  444   187   1,372   735 

Net income

  1,161  1,707  3,935  3,704  2,168   1,161   6,391   3,935 

Preferred stock dividends

  -  -  -  -        91    

Net income available to common stockholders

 $1,161 $1,707 $3,935 $3,704 $2,168  $1,161  $6,300  $3,935 

Basic earnings per common share

 $0.51 $0.77 $1.73 $1.70 $0.80  $0.51  $2.33  $1.73 

Diluted earnings per common share

  0.51  0.77  1.72  1.69  0.80   0.51   2.32   1.72 

Average common shares outstanding - basic

  2,271,139  2,204,949  2,271,139  2,174,210  2,698,712   2,271,139   2,698,712   2,271,139 

Average common shares outstanding - diluted

  2,291,286  2,220,420  2,288,723  2,190,647  2,719,528   2,291,286   2,715,957   2,288,723 

 

See accompanying notes to consolidated financial statements.

 

2

Table of Contents

 

 

Emclaire Financial Corp

Consolidated Statements of Comprehensive Income (Unaudited)

For the three and nine months ended September 30, 2018 and 2017

(Dollar amounts in thousands)

Emclaire Financial Corp
Consolidated Statements of Comprehensive Income (Unaudited)
For the three and nine months ended September 30, 2019 and 2018
(Dollar amounts in thousands)

 

 

For the three months ended

 

For the nine months ended

 

September 30,

 

September 30,

 For the Three Months Ended September 30, For the Nine Months Ended September 30,
 

2018

 

2017

 

2018

 

2017

 

2019

 

2018

 

2019

 

2018

Net income $1,161 $1,707 $3,935 $3,704 $2,168  $1,161  $6,391  $3,935 

Other comprehensive income (loss)

                            

Unrealized gains/(losses) on securities:

            

Unrealized holding gain/(loss) arising during the period

  (566)  232  (2,180)  638

Unrealized gains/(losses) on securities available-for-sale:

                

Unrealized holding gain (loss) arising during the period

  165   (564)  2,424   (2,155)

Reclassification adjustment for (gains) losses included in net income

  4  -  34  (350)  (42)  2   (43)  9 

Reclassification adjustment for other than temporary impairment losses included in net income

  -  -  -  508

Net period change

  (562)  232  (2,146)  796  123   (562)  2,381   (2,146)

Tax effect

  118  (79)  451  (271)  (26)  118   (500)  451 

Net of tax

  (444)  153  (1,695)  525  97   (444)  1,881   (1,695)
Comprehensive income $717 $1,860 $2,240 $4,229 $2,265  $717  $8,272  $2,240 

 

See accompanying notes to consolidated financial statements.

 

3

Table of Contents

 

 

Emclaire Financial Corp

Condensed Consolidated Statements of Cash Flows (Unaudited)

For the nine months ended September 30, 2018 and 2017

(Dollar amounts in thousands)

Emclaire Financial Corp
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the nine months ended September 30, 2019 and 2018
(Dollar amounts in thousands)

 

 

For the nine months ended

 

September 30,

 

2018

 

2017

 For the Nine Months Ended September 30,
       

2019

 

2018

Cash flows from operating activities

              

Net income

 $3,935 $3,704 $6,391  $3,935 

Adjustments to reconcile net income to net cash provided by operating activities:

              

Depreciation and amortization

  862  864

Depreciation and amortization of premises and equipment

  1,022   862 

Provision for loan losses

  980  633  305   980 

Amortization of premiums, net

  309  367

Amortization/accretion of premiums, discounts and deferred costs and fees, net

  235   309 

Amortization of operating lease right-of-use assets

  98    

Amortization of intangible assets and mortgage servicing rights

  244  213  182   244 

Securities impairment loss recognized in earnings

  -  508

Realized losses (gains) on sales of securities, net

  34  (350)

Realized (gains) losses on sales of debt securities, net

  (43)  9 

Change in fair value of equity securities, including realized gains

  (16)  (36)

Net gains on sales of loans

  (60)  (176)  (129)  (60)

Net losses on foreclosed real estate

  40  (10)

Gain on sale of premises and equipment

  (25)  -

Net loss on foreclosed real estate

  32   40 

Net gain on sale of premises and equipment

  (11)  (25)

Loans originated for sale

  (4,241)  (4,266)  (5,173)  (4,241)

Proceeds from the sale of loans originated for sale

  4,685  4,418  5,148   4,685 

Write-down of foreclosed real estate

  11  -  35   11 

Stock compensation expense

  187  164  271   187 

Increase in bank-owned life insurance, net

  (250)  (249)  (313)  (250)

Increase in accrued interest receivable

  (85)  (310)  (184)  (85)

(Increase) decrease in prepaid expenses and other assets

  (2,959)  1,265  154   (2,898)

Increase (decrease) in accrued interest payable

  47  154

Decrease in accrued expenses and other liabilities

  636  1,095

Gain on bargain purchase

  -  (1,307)

Increase in accrued interest payable

  157   47 

Increase (decrease) in accrued expenses and other liabilities

  (277)  636��

Net cash provided by operating activities

  4,350  6,717  7,884   4,350 

Cash flows from investing activities

              

Loan originations and principal collections, net

  (16,679)  (43,771)  19,327   (16,679)

Purchase of residential mortgage loans

  -  -

Proceeds from sales of loans held for sale previously classified as portfolio loans

  -  1,817

Settlement of syndicated national credits

  -  -

Securities:

      

Available-for-sale securities:

        

Sales

  12,683  18,195  21,035   12,683 

Maturities, repayments and calls

  6,822  7,818  12,946   6,822 

Purchases

  (18,645)  (25,163)  (51,871)  (18,645)

Net cash paid for acquisition

  -  2,517

Redemption of federal bank stocks

  196  (34)

Net change in federal bank stocks

  495   196 

Net increase in interest earning time deposits

  (3,460)  (2,540)

Proceeds from the sale of bank premises and equipment

  155  -  251   155 

Purchases of premises and equipment

  (1,492)  (574)

Proceeds from the sale of foreclosed real estate

  388  144  742   388 

Purchases of premises and equipment

  (574)  (279)

Net cash used in investing activities

  (15,654)  (38,756)  (2,027)  (18,194)

Cash flows from financing activities

              

Net increase in deposits

  27,718  57,864  46,479   27,718 

Repayments on long-term debt

  (5,750)  (750)  (750)  (5,750)

Proceeds from other long-term debt

  -  5,000

Net change in short-term borrowings

  (450)  (7,000)  (10,800)  (450)

Proceeds from exercise of stock options

  -  1,376

Dividends paid

  (1,908)  (1,763)  (2,439)  (1,908)

Net cash provided by financing activities

  19,610  54,727  32,490   19,610 

Increase in cash and cash equivalents

  8,306  22,688

Net increase in cash and cash equivalents

  38,347   5,766 

Cash and cash equivalents at beginning of period

  14,374  17,568  10,955   10,176 

Cash and cash equivalents at end of period

 $22,680 $40,256 $49,302  $15,942 

Supplemental information:

              

Interest paid

 $3,670 $3,070 $5,657  $3,670 

Income taxes paid

  560  875  910   560 

Supplemental noncash disclosure:

              

Transfers from loans to foreclosed real estate

  526  272  324   526 

Transfers from portfolio loans to loans held for sale

  -  1,725
      

Initial recognition of operating lease right-of-use assets

  1,642    

Initial recognition of operating lease liabilities

  1,858    

 

See accompanying notes to consolidated financial statements.

 

4

Table of Contents

 

 

Emclaire Financial Corp. and SubsidiaryCorp

Consolidated Statements of Changes in Stockholders'Stockholders’ Equity

(Unaudited)

For thethree and nine months ended September 30, 20182019 and 2017

2018

(Dollar amounts in thousands, except per share data)

 

 

Common

Stock

 

Additional

Paid-in Capital

 

Treasury

Stock

 

Retained

Earnings

 

Accumulated

Other Comprehensive Income

 

Total

Stockholders'

Equity

Balance at January 1, 2017

 $2,818 $27,900 $(2,114) $29,960 $(4,491) $54,073
Net income  -  -  -  3,704  -  3,704
Other comprehensive income  -  -  -  -  525  525
Stock compensation expense  -  164  -  -  -  164
Exercise of stock options (53,586 shares)  67  1,309  -  -  -  1,376
Issuance of common stock (58,445 shares)  73  1,601  -  -  -  1,674
Cash dividends declared on common stock ($0.81 per share)  -  -  -  (1,763)  -  (1,763)

Balance at September 30, 2017

 $2,958 $30,974 $(2,114) $31,901 $(3,966) $59,753
                  
                   Preferred Stock Additional Paid-in Capital - Preferred 

Common Stock

 

Additional Paid-in Capital - Common

 

Treasury Stock

 

Retained Earnings

 

Accumulated Other Comprehensive Loss

 

Total Stockholders' Equity

Balance at January 1, 2018, as previously presented

 $2,966 $31,031 $(2,114) $32,726 $(5,518) $59,091 $  $  $2,966  $31,031  $(2,114) $32,726  $(5,518) $59,091 
Cumulative effect of change in accounting principle for marketable equity securities, net of tax  -  -  -  187  (187)  -                 187   (187)   

Balance at January 1, 2018, as adjusted

 $2,966 $31,031 $(2,114) $32,913 $(5,705) $59,091 $  $  $2,966  $31,031  $(2,114) $32,913  $(5,705) $59,091 
Net income  -  -  -  3,935  -  3,935                 1,362      1,362 
Other comprehensive loss  -  -  -  -  (1,695)  (1,695)                    (1,015)  (1,015)
Stock compensation expense  -  187  -  -  -  187           75            75 
Cash dividends declared on common stock ($0.84 per share)  -  -  -  (1,908)  -  (1,908)

Cash dividends declared on common stock ($0.28 per share)

                 (636)     (636)
Balance at March 31, 2018        2,966   31,106   (2,114)  33,639   (6,720)  58,877 

Net income

                 1,413      1,413 

Other comprehensive loss

                    (236)  (236)

Stock compensation expense

           75            75 

Cash dividends declared on common stock ($0.28 per share)

                 (636)     (636)

Balance at June 30, 2018

        2,966   31,181   (2,114)  34,416   (6,956)  59,493 

Net income

                 1,161      1,161 
Other comprehensive loss                    (444)  (444)

Stock compensation expense

           37            37 
Cash dividends declared on common stock ($0.28 per share)                 (637)     (637)

Balance at September 30, 2018

 $2,966 $31,218 $(2,114) $34,940 $(7,400) $59,610 $  $  $2,966  $31,218  $(2,114) $34,940  $(7,400) $59,610 
                                

Balance at January 1, 2019, as previously presented

 $421  $3,785  $3,501  $46,401  $(2,114) $34,371  $(6,357) $80,008 

Cumulative effect of change in accounting principle for leases and security premiums, net of tax

                 (181)     (181)

Balance at January 1, 2019, as adjusted

 $421  $3,785  $3,501  $46,401  $(2,114) $34,190  $(6,357) $79,827 

Net income

                 2,082      2,082 

Other comprehensive income

                    873   873 

Stock compensation expense

           90            90 

Cash dividends declared on common stock ($0.29 per share)

                 (783)     (783)
Balance at March 31, 2019  421   3,785   3,501   46,491   (2,114)  35,489   (5,484)  82,089 
Net income                 2,140      2,140 

Other comprehensive income

                    911   911 

Cash dividends declared on preferred stock

                 (91)     (91)
Stock compensation expense           90            90 

Cash dividends declared on common stock ($0.29 per share)

                 (782)     (782)

Balance at June 30, 2019

  421   3,785   3,501   46,581   (2,114)  36,756   (4,573)  84,357 
Net income                 2,168      2,168 
Other comprehensive income                    97   97 
Stock compensation expense           91            91 
Cash dividends declared on common stock ($0.29 per share)                 (782)     (782)

Balance at September 30, 2019

 $421  $3,785  $3,501  $46,672  $(2,114) $38,142  $(4,476) $85,931 

 

See accompanying notes to consolidated financial statements.

 

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Emclaire Financial Corp

Notes to Consolidated Financial Statements (Unaudited)

 

 

1.

Nature of Operations and Basis of Presentation

 

Emclaire Financial Corp (the Corporation) is a Pennsylvania corporation and the holding company of The Farmers National Bank of Emlenton (the Bank) and Emclaire Settlement Services, LLC (the Title Company). The Corporation provides a variety of financial services to individuals and businesses through its offices in western Pennsylvania and northern West Virginia. Its primary deposit products are checking, savings and term certificate accounts and its primary lending products are residential and commercial mortgages, commercial business loans and consumer loans.

 

The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, the Bank and the Title Company. All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements.

 

The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Corporation’s consolidated financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission’s (SEC’s) Form 10-Q and Article 10 of Regulation S-X and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (GAAP). For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2017,2018, as contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 20172018 filed with the SEC.

 

The balance sheet at December 31, 20172018 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by GAAP for complete financial statements.

 

The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim quarterly or year-to-date periods are not necessarily indicative of the results that may be expected for the entire year or any other period. Certain amounts previously reported may have been reclassified to conform to the current year’s financial statement presentation.

 

2.

Mergers and Acquisitions

On October 1, 2018, the Corporation completed its acquisition of Community First Bancorp, Inc. (Community First), and its banking subsidiary Community First Bank, a Pennsylvania bank headquartered in Reynoldsville, Pennsylvania.

Under the terms of the merger agreement, Community First merged into the Corporation and shareholders of Community First received 1.2008 shares of the Corporation's common stock and $6.95 in cash for each share of common stock of Community First or approximately $15.6 million in common stock and $2.4 million in cash in the aggregate. In addition, Community First Bank merged into the Bank.

The transaction added total consolidated assets, loans and deposits of approximately $121.0 million, $111.6 million and $106.5 million, respectively.  Acquisition costs for the three and nine month periods were $677,000 and $1.0 million, respectively.  It is anticipated that the Corporation will recognize approximately $2.6 million of additional merger costs during the fourth quarter. The initial accounting for the acquisition is incomplete as the fair value adjustments to the acquired assets and assumed liabilities are not finalized.

6

 

 

3.2.

Earnings per Common Share

 

Basic earnings per common share (EPS) excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS includes the dilutive effect of additional potential common shares for assumed issuance of restricted stock and shares issued under stock options.stock.

 

The factors used in the Corporation’s earnings per common share computation follow:

 

(Dollar amounts in thousands, except for per share amounts)

 

For the three months ended

 

For the nine months ended

 For the Three Months Ended September 30, For the Nine Months Ended September 30,
 

September 30,

 

September 30,

 

2019

 

2018

 

2019

 

2018

 

2018

 

2017

 

2018

 

2017

Earnings per common share - basic

            

Earnings per common share

                

Net income

 $1,161 $1,707 $3,935 $3,704 $2,168  $1,161  $6,391  $3,935 

Less: Preferred stock dividends

  -  -  -  -        91    

Net income available to common stockholders

 $1,161 $1,707 $3,935 $3,704 $2,168  $1,161  $6,300  $3,935 

Average common shares outstanding

  2,271,139  2,204,949  2,271,139  2,174,210  2,698,712   2,271,139   2,698,712   2,271,139 

Add: Dilutive effects of restricted stock awards

  20,816   20,147   17,245   17,584 

Average shares and dilutive potential common shares

  2,719,528   2,291,286   2,715,957   2,288,723 

Basic earnings per common share

 $0.51 $0.77 $1.73 $1.70 $0.80  $0.51  $2.33  $1.73 

Earnings per common share - diluted

            

Net income available to common stockholders

 $1,161 $1,707 $3,935 $3,704

Average common shares outstanding

  2,271,139  2,204,949  2,271,139  2,174,210
Add: Dilutive effects of assumed issuance of restricted stock and exercise of stock options  20,147  15,471  17,584  16,437

Average shares and dilutive potential common shares

  2,291,286  2,220,420  2,288,723  2,190,647

Diluted earnings per common share

 $0.51 $0.77 $1.72 $1.69 $0.80  $0.51  $2.32  $1.72 

Stock options not considered in computing earnings per share because they were antidilutive

  -  -  -  -

Restricted stock awards not considered in computing earnings per share because they were antidulitive

            

 

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Table of Contents

 

 

4.3.

Securities

 

Equity Securities

 

The Corporation held equity securities with fair values of $473,000$23,000 and $1.8 million$7,000 at September 30, 20182019 and December 31, 2017,2018, respectively. Beginning January 1, 2018, with the adoption of ASU 2016-01, changes in the fair value of these securities are included in other income on the consolidated statements of net income as opposed to accumulated other comprehensive loss on the consolidated balance sheets. During the three and nine months ended September 30, 2018,2019, the Corporation recognized a loss gain of $1,000$6,000 and a gain of $62,000, respectively,$16,000, respectively, on the equity securities held at September 30, 2018.2019, compared to a net loss of $1,000 and $7,000, respectively, for the same periods in 2018. During the three and nine months ended September 30, 2018,2019, the Corporation did not sell any equity securities.  During the nine months ended September 30, 2018, the Corporation sold $1.2$1.2 million ofof equity securities with a realized net lossgain of $25,000.$43,000.

 

Debt Securities - Available for SaleAvailable-for-Sale

 

The following table summarizes the Corporation’s debt securities as of September 30, 20182019 and December 31, 2017:2018:

 

(Dollar amounts in thousands)

    

Gross

 

Gross

    

Amortized Cost

 

Gross Unrealized Gains

 

Gross Unrealized Losses

 

Fair Value

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Cost

 

Gains

 

Losses

 

Value

Available for sale:

            

September 30, 2018:

            

U.S. Treasury and federal agency

 $4,534 $- $(139) $4,395

September 30, 2019:

                

U.S. Treasury

 $4,024  $7  $(5) $4,026 

U.S. government sponsored entities and agencies

  17,058  -  (508)  16,550  8,085   18   (23)  8,080 

U.S. agency mortgage-backed securities: residential

  28,526  -  (862)  27,664  44,200   378   (40)  44,538 

U.S. agency collateralized mortgage obligations: residential

  20,171  36  (1,002)  19,205  30,714   105   (262)  30,557 

State and political subdivisions

  22,943  3  (686)  22,260  20,703   241   (34)  20,910 

Corporate debt securities

  7,520  1  (86)  7,435  9,713   97   (22)  9,788 

Total Securities available-for-sale

 $100,752 $40 $(3,283) $97,509

Total securities available-for-sale

 $117,439  $846  $(386) $117,899 
                            

December 31, 2017:

            

U.S. Treasury and federal agency

 $4,541 $- $(69) $4,472

December 31, 2018:

                

U.S. Treasury

 $4,532  $  $(87) $4,445 

U.S. government sponsored entities and agencies

  14,136  2  (212)  13,926  17,052   30   (299)  16,783 

U.S. agency mortgage-backed securities: residential

  20,904  7  (153)  20,758  27,666      (490)  27,176 

U.S. agency collateralized mortgage obligations: residential

  22,607  25  (708)  21,924  19,440   34   (810)  18,664 

State and political subdivisions

  29,249  87  (96)  29,240  22,943   13   (224)  22,732 

Corporate debt securities

  9,009  38  (17)  9,030  8,006   9   (97)  7,918 
Total Securities available-for-sale $100,446 $159 $(1,255) $99,350
            

Total securities available-for-sale

 $99,639  $86  $(2,007) $97,718 

 

The following table summarizes scheduled maturities of the Corporation’s debt securities as of September 30, 2018.2019. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are not due at a single maturity and are shown separately.

 

(Dollar amounts in thousands)

 

Available for sale

 

Available-for-sale

 

Amortized

 

Fair

 

Cost

 

Value

       

Amortized Cost

 

Fair Value

Due in one year or less

 $1,924 $1,912 $1,264  $1,261 

Due after one year through five years

  30,077  29,308  14,452   14,489 

Due after five through ten years

  15,305  14,803  12,109   12,283 

Due after ten years

  4,749  4,617  14,700   14,771 

Mortgage-backed securities: residential

  28,526  27,664  44,200   44,538 

Collateralized mortgage obligations: residential

 ��20,171  19,205  30,714   30,557 
Total $100,752 $97,509

Total securities available-for-sale

 $117,439  $117,899 

 

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4.3.

Securities (continued)

 

Information pertaining to debt securities with gross unrealized losses at September 30, 20182019 and December 31, 2017,2018, aggregated by investment category and length of time that individual securities have been in a continuous loss position are included in the table below:

 

(Dollar amounts in thousands)

 

Less than 12 Months

 

12 Months or More

 

Total

 

Less than 12 Months

 

12 Months or More

 

Total

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

Description of Securities

 

Value

 

Loss

 

Value

 

Loss

 

Value

 

Loss

 

Fair Value

 

Unrealized Loss

 

Fair Value

 

Unrealized Loss

 

Fair Value

 

Unrealized Loss

                  

September 30, 2018:

                  

U.S. Treasury and federal agency

 $- $- $4,395 $(139) $4,395 $(139)

September 30, 2019:

                        

U.S. Treasury

 $  $  $2,001  $(5) $2,001  $(5)

U.S. government sponsored entities and agencies

  7,796  (134)  8,754  (374)  16,550  (508)        6,062   (23)  6,062   (23)

U.S. agency mortgage-backed securities: residential

  21,938  (600)  5,726  (262)  27,664  (862)  10,940   (34)  3,557   (6)  14,497   (40)

U.S. agency collateralized mortgage obligations: residential

  1,500  (5)  15,870  (997)  17,370  (1,002)  6,773   (58)  12,485   (204)  19,258   (262)

State and political subdivisions

  17,386  (514)  4,325  (172)  21,711  (686)  4,642   (34)        4,642   (34)

Corporate debt securities

  2,936  (68)  484  (18)  3,420  (86)  2,702   (11)  488   (11)  3,190   (22)
Total $51,556 $(1,321) $39,554 $(1,962) $91,110 $(3,283) $25,057  $(137) $24,593  $(249) $49,650  $(386)

December 31, 2017:

                  

U.S. Treasury and federal agency

 $- $- $4,472 $(69) $4,472 $(69)
                        

December 31, 2018:

                        

U.S. Treasury

 $  $  $4,445  $(87) $4,445  $(87)

U.S. government sponsored entities and agencies

  3,447  (42)  8,975  (170)  12,422  (212)  2,472   (30)  10,337   (269)  12,809   (299)

U.S. agency mortgage-backed securities: residential

  9,659  (48)  6,581  (105)  16,240  (153)  19,483   (297)  7,693   (193)  27,176   (490)

U.S. agency collateralized mortgage obligations: residential

  954  (16)  19,147  (692)  20,101  (708)  1,443   (5)  15,388   (805)  16,831   (810)

State and political subdivisions

  10,510  (60)  3,487  (36)  13,997  (96)  7,061   (67)  10,083   (157)  17,144   (224)

Corporate debt securities

  2,992  (16)  999  (1)  3,991  (17)  962   (38)  2,448   (59)  3,410   (97)
Total $27,562 $(182) $43,661 $(1,073) $71,223 $(1,255) $31,421  $(437) $50,394  $(1,570) $81,815  $(2,007)

 

Gains/Gains and losses on sales of securities for the three and nine months ended September 30, were as follows:

 

(Dollar amounts in thousands)

 

For the three months

 

For the nine months

 For the Three Months Ended September 30, For the Nine Months Ended September 30,
 

ended September 30,

 

ended September 30,

 

2019

 

2018

 

2019

 

2018

 

2018

 

2017

 

2018

 

2017

Proceeds

 $5,888 $- $12,683 $18,195 $8,153  $5,888  $21,035  $12,683 

(Losses) Gains

  (4)  -  (34)  350

Tax provision related to gains

  (1)  -  (7)  119

Gains

  45   3   80   17 

Losses

  (3)  (5)  (37)  (26)

Tax provision related to gains (losses)

  9   (1)  9   (2)

 

Management evaluates debt securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other conditions warrant such evaluation. Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Corporation intends to sell an impaired security, or if it is more likely than not the Corporation will be required to sell the security before its anticipated recovery, the Corporation records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost. Otherwise, only the credit portion of the estimated loss on debt securities is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.

 

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4.

Securities (continued)

There were 13352 debt securities in an unrealized loss position as of September 30, 2018,2019, 35 of which 56 were in an unrealized loss position for more than 12 months. Of these 5635 securities, 2423 were government-backed collateralized mortgage obligations 12 were state and political subdivision securities, eight(issued by U.S. government sponsored entities), five were U.S. government sponsored entityentities and agency securities, sixfour were mortgage-backed securities, fivetwo were U.S. Treasury securities and one was a corporate security. The unrealized losses associated with these securities were not due to the deterioration in the credit quality of the issuer that would likely result in the non-collection of contractual principal and interest, but rather have been caused by a rise in interest rates from the time the securities were purchased. Based on that evaluation and other general considerations, and given that the Corporation’s current intention is not to sell any impaired securities and it is more likely than not it will not be required to sell these securities before the recovery of itstheir amortized cost basis, the Corporation does not consider these debt securities with unrealized losses as of September 30, 20182019 to be other-than-temporarily impaired.

 

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5.4.

Loans Receivable and Related Allowance for Loan Losses

 

The Corporation’s loans receivable as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)

 

September 30,

 

December 31,

 

September 30, 2019

 

December 31, 2018

 

2018

 

2017

              

Mortgage loans on real estate:

              

Residential first mortgages

 $237,106 $221,823 $287,437  $295,405 

Home equity loans and lines of credit

  99,668  99,940  98,628   103,752 

Commercial real estate

  200,169  193,068  227,569   238,734 

Total

  536,943  514,831

Total real estate loans

  613,634   637,891 

Other loans:

              

Commercial business

  52,594  58,941  69,834   66,009 

Consumer

  8,948  9,589  11,398   11,272 

Total

  61,542  68,530

Total other loans

  81,232   77,281 

Total loans, gross

  598,485  583,361  694,866   715,172 

Less allowance for loan losses

  6,360  6,127  6,509   6,508 

Total loans, net

 $592,125 $577,234 $688,357  $708,664 

 

Included in total loans above are net deferred costs of $1.9$2.3 million and $1.5$2.2 million at September 30, 20182019 and December 31, 2017,2018, respectively.

 

An allowance for loan losses (ALL) is maintained to absorb probable incurred losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience and the amount of nonperforming loans.

 

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

 

The allowance for loan losses is based on estimates and actual losses may vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

 

At September 30, 2018,2019, there was no allowance for loan losses allocated to loans acquired in the April 2016 acquisition offrom United American Savings Bank or the September 2017 acquisition of(2016), Northern Hancock Bank and Trust Co. (2017) or Community First Bancorp, Inc (2018).

 

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5.4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table details activity in the ALL and the recorded investment by portfolio segment based on impairment method:

 

(Dollar amounts in thousands)

(Dollar amounts in thousands)

 Residential Mortgages Home Equity & Lines of Credit 

Commercial Real Estate

 Commercial Business 

Consumer

 

Total

Three months ended September 30, 2019:

                        

Allowance for loan losses:

                        

Beginning Balance

 $2,225  $642  $3,043  $615  $55  $6,580 

Charge-offs

     (22)  (8)     (39)  (69)

Recoveries

     4   104      35   143 

Provision

  16   11   (185)  5   8   (145)

Ending Balance

 $2,241  $635  $2,954  $620  $59  $6,509 
    

Home Equity

                          ��         

Nine months ended September 30, 2019:

                        

Allowance for loan losses:

                        

Beginning Balance

 $2,198  $648  $3,106  $500  $56  $6,508 

Charge-offs

  (204)  (56)  (36)  (134)  (114)  (544)

Recoveries

  40   5   132      63   240 

Provision

  207   38   (248)  254   54   305 

Ending Balance

 $2,241  $635  $2,954  $620  $59  $6,509 
 

Residential

 

& Lines

 

Commercial

 

Commercial

                              

At September 30, 2019:

                        

Ending ALL balance attributable to loans:

                        

Individually evaluated for impairment

 $4  $  $  $  $  $4 

Acquired loans collectively evaluated for impairment

                  

Originated loans collectively evaluated for impairment

  2,237   635   2,954   620   59   6,505 

Total

 $2,241  $635  $2,954  $620  $59  $6,509 

Total loans:

                        

Individually evaluated for impairment

 $366  $4  $2,471  $40  $  $2,881 

Acquired loans collectively evaluated for impairment

  64,037   11,432   45,619   9,425   2,227   132,740 

Originated loans collectively evaluated for impairment

  223,034   87,192   179,479   60,369   9,171   559,245 

Total

 $287,437  $98,628  $227,569  $69,834  $11,398  $694,866 
                        

At December 31, 2018:

                        

Ending ALL balance attributable to loans:

                        

Individually evaluated for impairment

 $12  $  $  $  $  $12 

Acquired loans collectively evaluated for impairment

                  

Originated loans collectively evaluated for impairment

  2,186   648   3,106   500   56   6,496 

Total

 $2,198  $648  $3,106  $500  $56  $6,508 

Total loans:

                        

Individually evaluated for impairment

 $389  $6  $34  $39  $  $468 

Acquired loans collectively evaluated for impairment

  72,654   13,750   56,690   12,974   3,306   159,374 

Originated loans collectively evaluated for impairment

  222,362   89,996   182,010   52,996   7,966   555,330 

Total

 $295,405  $103,752  $238,734  $66,009  $11,272  $715,172 
 

Mortgages

 

of Credit

 

Real Estate

 

Business

 

Consumer

 

Total

                        
Three months ended September 30, 2018:                                          

Allowance for loan losses:

                                          

Beginning Balance

 $2,033 $650 $2,882 $499 $54 $6,118 $2,033  $650  $2,882  $499  $54  $6,118 

Charge-offs

  -  (26)  (6)  -  (44)  (76)     (26)  (6)     (44)  (76)

Recoveries

  -  1  13  -  4  18     1   13      4   18 

Provision

  128  34  81  11  46  300  128   34   81   11   46   300 

Ending Balance

 $2,161 $659 $2,970 $510 $60 $6,360 $2,161  $659  $2,970  $510  $60  $6,360 
                                          
Nine months ended September 30, 2018:                                          

Allowance for loan losses:

                                          

Beginning Balance

 $2,090 $646 $2,753 $585 $53 $6,127 $2,090  $646  $2,753  $585  $53  $6,127 

Charge-offs

  (61)  (109)  (424)  -  (213)  (807)  (61)  (109)  (424)     (213)  (807)

Recoveries

  3  12  32  1  12  60  3   12   32   1   12   60 

Provision

  129  110  609  (76)  208  980  129   110   609   (76)  208   980 

Ending Balance

 $2,161 $659 $2,970 $510 $60 $6,360 $2,161  $659  $2,970  $510  $60  $6,360 
                  

At September 30, 2018:

                  

Ending ALL balance attributable to loans:

                  

Individually evaluated for impairment

 $7 $- $- $- $- $7

Acquired loans

  -  -  -  -  -  -

Collectively evaluated for impairment

  2,154  659  2,970  510  60  6,353

Total

 $2,161 $659 $2,970 $510 $60 $6,360

Total loans:

                  

Individually evaluated for impairment

 $401 $6 $2,512 $39 $- $2,958

Acquired loans

  17,767  9,817  22,784  1,778  1,080  53,226

Collectively evaluated for impairment

  218,938  89,845  174,873  50,777  7,868  542,301

Total

 $237,106 $99,668 $200,169 $52,594 $8,948 $598,485
                  

At December 31, 2017:

                  

Ending ALL balance attributable to loans:

                  

Individually evaluated for impairment

 $7 $- $- $- $- $7

Acquired loans

  -  -  -  -  -  -

Collectively evaluated for impairment

  2,083  646  2,753  585  53  6,120

Total

 $2,090 $646 $2,753 $585 $53 $6,127

Total loans:

                  

Individually evaluated for impairment

 $425 $8 $914 $569 $- $1,916

Acquired loans

  20,300  10,873  27,404  1,451  2,893  62,921

Collectively evaluated for impairment

  201,098  89,059  164,750  56,921  6,696  518,524

Total

 $221,823 $99,940 $193,068 $58,941 $9,589 $583,361
                  
Three months ended September 30, 2017:                  

Allowance for loan losses:

                  

Beginning Balance

 $1,994 $639 $2,460 $621 $53 $5,767

Charge-offs

  (2)  (33)  (36)  (4)  (26)  (101)

Recoveries

  -  1  2  -  1  4

Provision

  46  20  200  (21)  25  270

Ending Balance

 $2,038 $627 $2,626 $596 $53 $5,940
                  
Nine months ended September 30, 2017:                  

Allowance for loan losses:

                  

Beginning Balance

 $1,846 $633 $2,314 $700 $52 $5,545

Charge-offs

  (38)  (44)  (126)  (14)  (53)  (275)

Recoveries

  -  21  6  -  10  37

Provision

  230  17  432  (90)  44  633

Ending Balance

 $2,038 $627 $2,626 $596 $53 $5,940

 

11

Table of Contents

 

5.4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of September 30, 2018:2019:

 

(Dollar amounts in thousands)

 

Impaired Loans with Specific Allowance

          

For the three months

 

As of September 30, 2018

 

ended September 30, 2018

                Cash Basis

(Dollar amounts in thousands)

                        
 

Unpaid

       

Average

 

Interest Income

 

Interest

 

Impaired Loans with Specific Allowance

 

Principal

 

Recorded

 

Related

 

Recorded

 

Recognized

 

Recognized

 

As of September 30, 2019

 

For three months ended September 30, 2019

 

Balance

 

Investment

 

Allowance

 

Investment

 

in Period

 

in Period

 Unpaid Principal Balance Recorded Investment Related Allowance Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $74 $74 $7 $74 $1 $1 $72  $72  $4  $72  $1  $1 

Home equity and lines of credit

  6  6  -  7  -  -  4   4      5       

Commercial real estate

  -  -  -  -  -  -                  

Commercial business

  -  -  -  -  -  -                  

Consumer

  -  -  -  -  -  -                  

Total

 $80 $80 $7 $81 $1 $1 $76  $76  $4  $77  $1  $1 

 

 

For the nine months

 

ended September 30, 2018

       

Cash Basis

 

Average

 

Interest Income

 

Interest

 

Recorded

 

Recognized

 

Recognized

 

For the nine months ended September 30, 2019

 

Investment

 

in Period

 

in Period

 Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $75 $2 $2 $73  $3  $3 

Home equity and lines of credit

  7  -  -  5       

Commercial real estate

  -  -  -         

Commercial business

  -  -  -  16       

Consumer

  -  -  -         

Total

 $82 $2 $2 $94  $3  $3 

 

 

Impaired Loans with No Specific Allowance

       

For the three months 

 

As of September 30, 2018

 

ended September 30, 2018

             Cash Basis
 

Unpaid

    

Average

 

Interest Income

 

Interest

 

Impaired Loans with No Specific Allowance

 

Principal

 

Recorded

 

Recorded

 

Recognized

 

Recognized

 

As of September 30, 2019

 

For three months ended September 30, 2019

 

Balance

 

Investment

 

Investment

 

in Period

 

in Period

 Unpaid Principal Balance Recorded Investment Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $438 $327 $330 $2 $2 $369  $294  $298  $2  $2 

Home equity and lines of credit

  -  -  -  -  -               

Commercial real estate

  2,512  2,512  1,278  83  2  2,471   2,471   2,475   34   33 

Commercial business

  39  39  39  1  1  40   40   139       

Consumer

  -  -  -  -  -               

Total

 $2,989 $2,878 $1,647 $86 $5 $2,880  $2,805  $2,912  $36  $35 

 

 

For the nine months

 

ended September 30, 2018

       

Cash Basis

 

Average

 

Interest Income

 

Interest

 

Recorded

 

Recognized

 

Recognized

 

For the nine months ended September 30, 2019

 

Investment

 

in Period

 

in Period

 Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $338 $3 $3 $305  $3  $3 

Home equity and lines of credit

  -  -  -         

Commercial real estate

  952  125  42  1,254   87   34 

Commercial business

  300  74  74  89   7   2 

Consumer

  -  -  -         

Total

 $1,590 $202 $119 $1,648  $97  $39 

 

12

Table of Contents

 

5.4.

Loans Receivable and Related Allowance for Loan Losses (continued)

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2018:

(Dollar amounts in thousands)

                        
  

Impaired Loans with Specific Allowance

  

As of December 31, 2018

 

For the year ended December 31, 2018

  Unpaid Principal Balance Recorded Investment Related Allowance Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $74  $74  $12  $74  $2  $2 
Home equity and lines of credit  6   6      7       
Commercial real estate                  
Commercial business                  
Consumer                  
Total $80  $80  $12  $81  $2  $2 

  

Impaired Loans with No Specific Allowance

  

As of December 31, 2018

 

For the year ended December 31, 2018

  Unpaid Principal Balance Recorded Investment Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $427  $315  $334  $5  $5 

Home equity and lines of credit

               

Commercial real estate

  34   34   768   156   73 

Commercial business

  39   39   248   74   74 

Consumer

               

Total

 $500  $388  $1,350  $235  $152 

13

Table of Contents

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2017:September 30, 2018:

 

(Dollar amounts in thousands)
 

Impaired Loans with Specific Allowance

          

For the year ended

 

As of December 31, 2017

 

December 31, 2017

                

Cash Basis

(Dollar amounts in thousands)

                        
 

Unpaid

       

Average

 

Interest Income

 

Interest

 

Impaired Loans with Specific Allowance

 

Principal

 

Recorded

 

Related

 

Recorded

 

Recognized

 

Recognized

 

As of September 30, 2018

 

For the three months ended September 30, 2018

 

Balance

 

Investment

 

Allowance

 

Investment

 

in Period

 

in Period

 Unpaid Principal Balance Recorded Investment Related Allowance Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $75 $75 $7 $88 $3 $3 $74  $74  $7  $74  $1  $1 

Home equity and lines of credit

  8  8  -  2  -  -  6   6      7       

Commercial real estate

  -  -  -  111  -  -                  

Commercial business

  -  -  -  118  -  -                  

Consumer

  -  -  -  -  -  -                  

Total

 $83 $83 $7 $319 $3 $3 $80  $80  $7  $81  $1  $1 

 

  

Impaired Loans with No Specific Allowance

        

For the year ended

  

As of December 31, 2017

 

December 31, 2017

              

Cash Basis

  

Unpaid

    

Average

 

Interest Income

 

Interest

  

Principal

 

Recorded

 

Recorded

 

Recognized

 

Recognized

  

Balance

 

Investment

 

Investment

 

in Period

 

in Period

Residential first mortgages

 $461 $350 $289 $8 $8

Home equity and lines of credit

  -  -  -  -  -

Commercial real estate

  1,089  914  855  3  3

Commercial business

  569  569  498  3  3

Consumer

  -  -  -  -  -

Total

 $2,119 $1,833 $1,642 $14 $14

13

Table of Contents

5.

Loans Receivable and Related Allowance for Loan Losses (continued)

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of September 30, 2017:

(Dollar amounts in thousands)
 

Impaired Loans with Specific Allowance

          

For the three months

 

As of September 30, 2017

 

ended September 30, 2017

                Cash Basis
 

Unpaid

       

Average

 

Interest Income

 

Interest

 

Principal

 

Recorded

 

Related

 

Recorded

 

Recognized

 

Recognized

 

For the nine months ended September 30, 2018

 

Balance

 

Investment

 

Allowance

 

Investment

 

in Period

 

in Period

 Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $76 $76 $8 $76 $- $- $75  $2  $2 

Home equity and lines of credit

  -  -  -  -  -  -  7       

Commercial real estate

  -  -  -  -  -  -         

Commercial business

  -  -  -  -  -  -         

Consumer

  -  -  -  -  -  -         

Total

 $76 $76 $8 $76 $- $- $82  $2  $2 

 

 

For the nine months

 

ended September 30, 2017

       

Cash Basis

 

Average

 

Interest Income

 

Interest

 

Impaired Loans with No Specific Allowance

 

Recorded

 

Recognized

 

Recognized

 

As of September 30, 2018

 

For the three months ended September 30, 2018

 

Investment

 

in Period

 

in Period

 Unpaid Principal Balance Recorded Investment Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $91 $2 $2 $438  $327  $330  $2  $2 

Home equity and lines of credit

  -  -  -               

Commercial real estate

  139  -  -  2,512   2,512   1,278   83   2 

Commercial business

  147  -  -  39   39   39   1   1 

Consumer

  -  -  -               

Total

 $377 $2 $2 $2,989  $2,878  $1,647  $86  $5 

 

  

Impaired Loans with No Specific Allowance

        

For the three months

  

As of September 30, 2017

 

ended September 30, 2017

              Cash Basis
  

Unpaid

    

Average

 

Interest Income

 

Interest

  

Principal

 

Recorded

 

Recorded

 

Recognized

 

Recognized

  

Balance

 

Investment

 

Investment

 

in Period

 

in Period

Residential first mortgages

 $469 $357 $362 $1 $1

Home equity and lines of credit

  -  -  -  -  -

Commercial real estate

  1,113  939  957  1  1

Commercial business

  585  585  592  1  1

Consumer

  -  -  -  -  -

Total

 $2,167 $1,881 $1,911 $3 $3

 

For the nine months

 

ended September 30, 2017

       

Cash Basis

 

Average

 

Interest Income

 

Interest

 

Recorded

 

Recognized

 

Recognized

 

For the nine months ended September 30, 2018

 

Investment

 

in Period

 

in Period

 Average Recorded Investment Interest Income Recognized in Period Cash Basis Interest Recognized in Period

Residential first mortgages

 $274 $5 $5 $338  $3  $3 

Home equity and lines of credit

  -  -  -         

Commercial real estate

  840  2  2  952   125   42 

Commercial business

  481  2  2  300   74   74 

Consumer

  -  -  -         

Total

 $1,595 $9 $9 $1,590  $202  $119 

14

Table of Contents

5.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

Unpaid principal balance includes any loans that have been partially charged off but not forgiven. Accrued interest is not included in the recorded investment in loans presented above or in the tables that follow based on the amounts not being material.

 

14

Table of Contents

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

Troubled debt restructurings (TDR). The Corporation has certain loans that have been modified in order to maximize collection of loan balances. If, for economic or legal reasons related to the customer’s financial difficulties, management grants a concession compared to the original terms and conditions of the loan that it would not have otherwise considered, the modified loan is classified as a TDR. Concessions related to TDRs generally do not include forgiveness of principal balances. The Corporation generally does not extend additional credit to borrowers with loans classified as TDRs.

At September 30, 20182019 and December 31, 2017,2018, the Corporation had $407,000$433,000 and $433,000,$394,000, respectively, of loans classified as TDRs, which are included in impaired loans above. The Corporation had allocated $7,000$4,000 and $7,000$12,000 of specific allowance for these loans at September 30, 20182019 and December 31, 2017,2018, respectively.

During the three and nine month periodsmonths ended September 30, 2018 2019, the Corporation did not modify any loans as TDRs.  During the three month periodnine months ended September 30, 2017, the Corporation did not modify any loans as TDRs.  During the nine month period ended September 30, 2017,2019, the Corporation modified the interest rate and extended the payment amortization on one residential mortgagecommercial real estate loan with a recorded investment of $323,000 due to a bankruptcy order.$72,000. At September 30, 2017,2019, the Corporation did not have any specific allowance for loan losses allocated to this specific loan. During the three and nine months ended September 30, 2018, the Corporation did not modify any loans as TDRs.

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. During the three and nine month periodsmonths ended September 30, 20182019 and 2017,2018, the Corporation did not have any loans which were modified as TDRs for which there was a payment default within twelve months following the modification.

Credit Quality Indicators. Management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.

Commercial real estate and commercial business loans not identified as impaired are evaluated as risk rated pools of loans utilizing a risk rating practice that is supported by a quarterly special asset review. In this review process, strengths and weaknesses are identified, evaluated and documented for each criticized and classified loan and borrower, strategic action plans are developed, risk ratings are confirmed and the loan’s performance status is reviewed.

 

Management has determined certain portions of the loan portfolio to be homogeneous in nature and assigns like reserve factors for the following loan pool types: residential real estate, home equity loans and lines of credit, and consumer installment and personal lines of credit.

 

The reserve allocation for risk rated loan pools is developed by applying the following factors:

 

Historic: Management utilizes a computer model to develop the historical net charge-off experience which is used to formulate the assumptions employed in the migration analysis applied to estimate losses in the portfolio. Outstanding balance and charge-off information are input into the model and historical loss migration rate assumptions are developed to apply to pass, special mention, substandard and doubtful risk rated loans. A twelve-quarter rolling weighted-average is utilized to estimate probable incurred losses in the portfolios.

 

Qualitative: Qualitative adjustment factors for pass, special mention, substandard and doubtful ratings are developed and applied to risk rated loans to allow for: quality of lending policies and procedures; national and local economic and business conditions; changes in the nature and volume of the portfolio; experiences, ability and depth of lending management; changes in trends, volume and severity of past due, nonaccrual and classified loans and loss and recovery trends; quality of loan review systems; concentrations of credit and other external factors.

 

15

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

Management uses the following definitions for risk ratings:

 

Pass: Loans classified as pass typically exhibit good payment performance and have underlying borrowers with acceptable financial trends where repayment capacity is evident. These borrowers typically would have a sufficient cash flow that would allow them to weather an economic downturn and the value of any underlying collateral could withstand a moderate degree of depreciation due to economic conditions.

15

Table of Contents

5.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

Special Mention: Loans classified as special mention are characterized by potential weaknesses that could jeopardize repayment as contractually agreed. These loans may exhibit adverse trends such as increasing leverage, shrinking profit margins and/or deteriorating cash flows. These borrowers would inherently be more vulnerable to the application of economic pressures.

 

Substandard: Loans classified as substandard exhibit weaknesses that are well-defined to the point that repayment is jeopardized. Typically, the Corporation is no longer adequately protected by both the apparent net worth and repayment capacity of the borrower.

 

Doubtful: Loans classified as doubtful have advanced to the point that collection or liquidation in full, on the basis of currently ascertainable facts, conditions and value, is highly questionable or improbable.

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass and the criticized categories of special mention, substandard and doubtful within the Corporation’s internal risk rating system as of September 30, 20182019 and December 31, 2017:2018:

 

(Dollar amounts in thousands)

(Dollar amounts in thousands)

                        
       

Special

          

Not Rated

 

Pass

 Special Mention 

Substandard

 

Doubtful

 

Total

 

Not Rated

 

Pass

 

Mention

 

Substandard

 

Doubtful

 

Total

September 30, 2018:

                  

September 30, 2019:

                        

Residential first mortgages

 $235,817 $- $- $1,289 $- $237,106 $286,353  $  $  $1,084  $  $287,437 

Home equity and lines of credit

  98,647  -  -  1,021  -  99,668  97,956         672      98,628 

Commercial real estate

  -  189,273  3,785  7,111  -  200,169     211,535   3,381   12,653      227,569 

Commercial business

  -  51,381  150  1,063  -  52,594     66,935   204   2,695      69,834 

Consumer

  8,851  -  -  97  -  8,948  11,317         81      11,398 

Total

 $343,315 $240,654 $3,935 $10,581 $- $598,485

Total loans

 $395,626  $278,470  $3,585  $17,185  $  $694,866 
                                    

December 31, 2017:

                  

December 31, 2018:

                        

Residential first mortgages

 $220,730 $- $- $1,093 $- $221,823 $293,919  $  $  $1,486  $  $295,405 

Home equity and lines of credit

  98,946  -  -  994  -  99,940  102,869         883      103,752 

Commercial real estate

  -  182,460  2,744  7,864  -  193,068     222,335   5,942   10,457      238,734 

Commercial business

  -  56,960  477  1,504  -  58,941     62,022   542   3,445      66,009 

Consumer

  9,443  -  -  146  -  9,589  11,157         115      11,272 

Total

 $329,119 $239,420 $3,221 $11,601 $- $583,361

Total loans

 $407,945  $284,357  $6,484  $16,386  $  $715,172 

 

16

Table of Contents

 

5.4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonperforming loans as of September 30, 20182019 and December 31, 2017:2018:

 

(Dollar amounts in thousands)

(Dollar amounts in thousands)

                        
 

Performing

 

Nonperforming

    

Performing

 

Nonperforming

    
 

Accruing

 

Accruing

 

Accruing

 

Accruing

       Accruing Loans Not Past Due Accruing 30-59 Days Past Due Accruing 60-89 Days Past Due 

Accruing 90+ Days Past Due

 

Nonaccrual

 

Total

 

Loans Not

 

30-59 Days

 

60-89 Days

 

90 Days +

    

Total

 

Past Due

 

Past Due

 

Past Due

 

Past Due

 

Nonaccrual

 

Loans

September 30, 2018:

                  

September 30, 2019:

                        

Residential first mortgages

 $233,448 $2,019 $427 $129 $1,083 $237,106 $282,766  $2,626  $1,024  $197  $824  $287,437 

Home equity and lines of credit

  97,716  906  146  379  521  99,668  97,361   438   187   110   532   98,628 

Commercial real estate

  196,184  737  8  -  3,240  200,169  222,078   2,172   126      3,193   227,569 

Commercial business

  52,233  322  -  -  39  52,594  69,653   76   65      40   69,834 

Consumer

  8,704  97  50  27  70  8,948  11,240   75   2      81   11,398 

Total loans

 $588,285 $4,081 $631 $535 $4,953 $598,485 $683,098  $5,387  $1,404  $307  $4,670  $694,866 
                                          

December 31, 2017:

                  

December 31, 2018:

                        

Residential first mortgages

 $218,515 $1,936 $357 $159 $856 $221,823 $289,732  $3,586  $747  $485  $855  $295,405 

Home equity and lines of credit

  98,112  598  370  334  526  99,940  101,920   707   351   287   487   103,752 

Commercial real estate

  190,451  1,026  430  197  964  193,068  232,865   5,013   231   19   606   238,734 

Commercial business

  58,058  74  225  -  584  58,941  65,538   50   247      174   66,009 

Consumer

  9,162  273  81  -  73  9,589  10,961   160   36      115   11,272 

Total loans

 $574,298 $3,907 $1,463 $690 $3,003 $583,361 $701,016  $9,516  $1,612  $791  $2,237  $715,172 

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5.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents the Corporation’s nonaccrual loans by aging category as of September 30, 20182019 and December 31, 2017:2018:

 

(Dollar amounts in thousands)

(Dollar amounts in thousands)

                    
 

Not

 

30-59 Days

 

60-89 Days

 

90 Days +

 

Total

 Not Past Due 30-59 Days Past Due 60-89 Days Past Due 90 Days + Past Due 

Total

 

Past Due

 

Past Due

 

Past Due

 

Past Due

 

Loans

               

September 30, 2018:

               

September 30, 2019:

                    

Residential first mortgages

 $346 $- $74 $663 $1,083 $315  $72  $  $437  $824 

Home equity and lines of credit

  7  -  -  514  521  4         528   532 

Commercial real estate

  2,665  -  268  307  3,240  135   454   45   2,559   3,193 

Commercial business

  39  -  -  -  39  40            40 

Consumer

  -  -  -  70  70           81   81 

Total loans

 $3,057 $- $342 $1,554 $4,953 $494  $526  $45  $3,605  $4,670 
                              

December 31, 2017:

               

December 31, 2018:

                    

Residential first mortgages

 $366 $- $75 $415 $856 $335  $  $74  $446  $855 

Home equity and lines of credit

  8  -  -  518  526  6         481   487 

Commercial real estate

  341  -  -  623  964  111   265      230   606 

Commercial business

  569  -  -  15  584        39   135   174 

Consumer

  -  -  -  73  73           115   115 

Total loans

 $1,284 $- $75 $1,644 $3,003 $452  $265  $113  $1,407  $2,237 

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6.5.

Goodwill and Intangible Assets

 

The following table summarizes the Corporation’s acquired goodwill and intangible assets as of September 30, 20182019 and December 31, 2017:2018: 

 

(Dollar amounts in thousands)

 

September 30, 2018

 

December 31, 2017

 

September 30, 2019

 

December 31, 2018

 

Gross Carrying Amount

 

Accumulated Amortization

 

Gross Carrying Amount

 

Accumulated Amortization

 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization

Goodwill

 $10,288 $- $10,288 $- $19,460  $  $19,448  $ 

Core deposit intangibles

  4,426  4,148  4,426  3,945  5,634   4,345   5,634   4,211 

Total

 $14,714 $4,148 $14,714 $3,945 $25,094  $4,345  $25,082  $4,211 

 

Goodwill resulted from fourfive acquisitions. Goodwill represents the excess of the total purchase price paid for the acquisitions over the fair value of the identifiable assets acquired, net of the fair value of the liabilities assumed. Goodwill is not amortized but is evaluated for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. The Corporation has selected November 30 as the date to perform the annual impairment test. No goodwill impairment charges were recorded during 20172018 or in the first nine months of 2018.2019.

 

The core deposit intangible asset, resulting from three acquisitions, is amortized using the double declining balance method over a weighted average estimated life of the related deposits and is not estimated to have a significant residual value. During the three and nine month periods endingmonths ended September 30, 20182019, the Corporation recorded intangible amortization expense totaling $67,000$44,000 and $203,000,$134,000, respectively, compared to $58,000$67,000 and $177,000,$203,000, respectively, for the same periods in 2017.2018.

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7.6.

Stock Compensation Plan

 

In April 2014, the Corporation adopted the 2014 Stock Incentive Plan (the 2014 Plan), which is shareholderwas approved by shareholders and permits the grant of restricted stock awards and options to its directors, officers and employees for up to 176,866 shares of common stock. As of September 30, 2018, 52,5332019, 37,783 shares of restricted stock and 88,433 stock options remain available for issuance under the plan.Plan.

 

Incentive stock options, non-incentive or compensatory stock options and share awards may be granted under the Plan. The exercise price of each option shall at least equal the market price of a share of common stock on the date of grant and have a contractual term of ten years. Options shall vest and become exercisable at the rate, to the extent and subject to such limitations as may be specified by the Corporation. Compensation cost related to share-based payment transactions must be recognized in the financial statements with measurement based upon the fair value of the equity instruments issued.

 

At September 30, 20182019, there arewere no options that were granted or outstanding under the Plan.

 

A summary of the status of the Corporation’s nonvested restricted stock awards as of September 30, 2018,2019, and changes during the period then ended is presented below:

 

    

Weighted-Average

 

Shares

 Weighted-Average Grant-date Fair Value
 

Shares

 

Grant-date Fair Value

Nonvested at January 1, 2018

  33,400 $27.70

Nonvested at January 1, 2019

  37,250  $29.94 

Granted

  -  -      

Vested

  -  -      

Forfeited

  (2,500)  27.17      

Nonvested as of September 30, 2018

  30,900 $27.74

Nonvested as of September 30, 2019

  37,250  $29.94 

 

For the three and nine month periodsmonths ended September 30, 2018,2019, the Corporation recognized stock compensation expense of $90,000 and $271,000, respectively, compared to $37,000 and $187,000, respectively compared to $55,000 and $164,000, respectively, for the same periodperiods in 2017.2018. As of September 30, 2018,2019, there was $411,000$513,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over the next three years. It is the Corporation’s policy to issue shares on the vesting date for restricted stock awards. Unvested restricted stock awards do not receive dividends declared by the Corporation.

 

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8.7.

Fair Value

 

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sale transaction or exit price on the date indicated. The estimated fair value amounts have been measured as of their respective datesyear-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported.

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value.

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Corporation has the ability to accessAssets measured at the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect the Corporation’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

19

8.

Fair Value (continued)

An asset or liability’s level is based on the lowest level of input that is significant to the fair value measurement.

on a recurring basis. The Corporation used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:the following assets:

 

Securities (debt-available for sale, equities)Debt securities available-for-sale, equity securities – The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. If available, investment securities are determined by quoted market prices (Level 1). Level 1 includes U.S. Treasury, federal agency securities and certain equity securities. For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). Level 2 includes U.S. Government sponsored entities and agencies, mortgage-backed securities, collateralized mortgage obligations, state and political subdivision securities and certain corporate debt securities. For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using unobservable inputs (Level 3) and may include certain corporate debt and equity securities held by the Corporation.

For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

(Dollar amounts in thousands)

     

(Level 1)

 

(Level 2)

 

(Level 3)

Description

 

Total

 Quoted Prices in Active Markets for Identical Assets Significant Other Observable Inputs Significant Unobservable Inputs

September 30, 2019:

                

Securities available-for-sale

                

U.S. Treasury

 $4,026  $4,026  $  $ 

U.S. government sponsored entities and agencies

  8,080      8,080    

U.S. agency mortgage-backed securities: residential

  44,538      44,538    

U.S. agency collateralized mortgage obligations: residential

  30,557      30,557    

State and political subdivision

  20,910      20,910    

Corporate debt securities

  9,788      6,288   3,500 

Total available-for-sale securities

 $117,899  $4,026  $110,373  $3,500 
                 

Equity securities

 $23  $23  $  $ 
                 

December 31, 2018:

                

Securities available-for-sale

                

U.S. Treasury

 $4,445  $4,445  $  $ 

U.S. government sponsored entities and agencies

  16,783      16,783    

U.S. agency mortgage-backed securities: residential

  27,176      27,176    

U.S. agency collateralized mortgage obligations: residential

  18,664      18,664    

State and political subdivisions

  22,732      22,732    

Corporate debt securities

  7,918      4,418   3,500 

Total available-for-sale securities

 $97,718  $4,445  $89,773  $3,500 
                 

Equity securities

 $7  $7  $  $ 

The Corporation’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period. During the nine months ended September 30, 2019, the Corporation reclassified one corporate security from Level 3 to Level 2. For the same period in 2018, the Corporation reclassified a restricted bank stock from the equity security portfolio to other assets and certain corporate debt securities consistfrom Level 3 to Level 2.  Also during 2018, the Corporation sold $25,000 in equity securities from Level 3.

19

7.

Fair Value (continued)

The following table presents changes in Level 3 assets measured on a recurring basis for the three and nine month periods ended September 30, 2019 and 2018:

(Dollar amounts in thousands)

 Three months ended September 30, Nine months ended September 30,
  

2019

 

2018

 

2019

 

2018

Balance at the beginning of the period

 $3,000  $3,500  $3,500  $8,132 

Total gains or losses (realized/unrealized):

                

Included in earnings

           1 

Included in other comprehensive income

            

Purchased into Level 3

  500      500    

Sold out of Level 3

           (25)

Transfers in and/or out of Level 3

        (500)  (4,608)

Balance at the end of the period

 $3,500  $3,500  $3,500  $3,500 

Assets measured at par because management has determined thatfair value on a non-recurring basis. The Corporation used the par value approximatesfollowing methods and significant assumptions to estimate the fair value of these instruments. The Level 3 equity security valuations were supported by an analysis prepared by the Corporation which relies on inputs such as the security issuer’s publicly attainable financial information, multiples derived from prices in observed transactions involving comparable businesses and other market, financial and nonfinancial factors.following assets:

 

Impaired loans – At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive a specific allowance for loan losses. For collateral dependent loans, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. As of September 30, 20182019 and December 31, 2017,2018, the Corporation did not have any impaired loans carried at fair value measured using the fair value of collateral. ThereDuring the three month period ended September 30, 2019 there was no additional provision for loan losses recorded for impaired loans.  There was additional provision for loan losses recorded for impaired loans of $63,000 during the nine month period ended September 30, 2019, however, the loan was charged-off prior to the end of the second quarter.  There were no additional provisions recorded for impaired loans during the three and nine monthsame periods ended September 30, in 2018 and 2017..

 

Other real estate owned(OREO) – Assets acquired through or instead of foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to the valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. As of September 30, 20182019 and December 31, 2017,2018, respectively, the Corporation did not have anyhad no OREO measured at fair value. During the three month periods ended September 30, 2019 and 2018, there was no expense recorded associated with the write-down of OREO.  During the nine month periods ended September 30, 2019 and 2018, there was expense recorded of $35,000 and $11,000, respectively.  The related properties were sold prior to the end of the respective reporting periods.  As of December 31, 2018, OREO measured at fair value less costs to sell had a net carrying amount of $160,000, which consisted of the outstanding balance of $415,000 less write-downs of $255,000.

 

Appraisals for both collateral-dependent impaired loans and OREO are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed by the Corporation. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Corporation compares the actual selling price of OREO that has been sold to the most recent appraisalappraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value. The most recent analysis performed indicated that a discount of 10% should be applied.

 

20

8.

Fair Value (continued)

For assets measured at fair value on a recurringnon-recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

 

(Dollar amounts in thousands)

    

(Level 1)

 

(Level 2)

   
     

Quoted Prices in

 

Significant

 

(Level 3)

     

Active Market

 

Other

 

Significant

     

for Identical

 

Observable

 

Unobservable

Description

 

Total

 

Assets

 

Inputs

 

Inputs

September 30, 2018:

            

Securities available for sale

            

U.S. Treasury and federal agency

 $4,395 $4,395 $- $-

U.S. government sponsored entities and agencies

  16,550  -  16,550  -

U.S. agency mortgage-backed securities: residential

  27,664  -  27,664  -

U.S. agency collateralized mortgage obligations: residential

  19,205  -  19,205  -

State and political subdivision

  22,260  -  22,260  -

Corporate debt securities

  7,435  -  3,935  3,500
Total $97,509 $4,395 $89,614 $3,500
             

Equity securities

 $473 $473 $- $-
             

December 31, 2017:

            

Securities available for sale

            

U.S. Treasury and federal agency

 $4,472 $4,472 $- $-

U.S. government sponsored entities and agencies

  13,926  -  13,926  -

U.S. agency mortgage-backed securities: residential

  20,758  -  20,758  -

U.S. agency collateralized mortgage obligations: residential

  21,924  -  21,924  -

State and political subdivisions

  29,240  -  29,240  -

Corporate debt securities

  9,030  -  1,032  7,998
Total $99,350 $4,472 $86,880 $7,998
             

Equity securities

 $1,817 $1,683 $- $134

(Dollar amounts in thousands)

     

(Level 1)

 

(Level 2)

 

(Level 3)

Description

 

Total

 Quoted Prices in Active Markets for Identical Assets Significant Other Observable Inputs Significant Unobservable Inputs

December 31, 2018:

                

Other real estate owned

 $160  $  $  $160 

Total

 $160  $  $  $160 

 

2120

 

8.7.

Fair Value (continued)

 

The Corporation’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period. During the nine month period ended September 30, 2018 the Corporation reclassified a restricted bank stock from the equity security portfolio to other assets and certain corporate securities from Level 3 to Level 2. Also during the nine month period, $25,000 in Level 3 equity securities were sold from the portfolio. For the same period in 2017, the Corporation had no transfers between levels. The following table presents changes inquantitative information about Level 3 assets measured on a recurring basisfair value measurements for the three and nine month periods ended September 30, 2018 and 2017:

(Dollar amounts in thousands)

 

Three months ended

 

Nine months ended

  

September 30,

 

September 30,

  

2018

 

2017

 

2018

 

2017

Balance at the beginning of the period

 $3,500 $135 $8,132 $136

Total gains or losses (realized/unrealized):

  -  -  -  -

Included in earnings

  -  -  1  -

Included in other comprehensive income

  -  (1)  -  (2)

Acquired

  -  -  -  -
Sold out of Level 3  -  -  (25)  -

Transfers in and/or out of Level 3

  -  -  (4,608)  -

Balance at the end of the period

 $3,500 $134 $3,500 $134

The Corporation had no OREO assets measured at fair value on a non-recurring basis at basis:

(Dollar amounts in thousands)

    

Valuation

Unobservable

Weighted

     

Techniques(s)

Input (s)

Average

December 31, 2018:

         

Other real estate owned

 $160 

Sales comparison approach

Adjustment for differences between comparable sales

 10%

At September 30, 20182019 and December 31, 2017.

The Corporation had2018 was an impaired residential mortgage loan totaling $62,000$68,000 and $61,000, respectively, and an impaired home equity loan totaling $4,000 and $6,000, at September 30, 2018respectively, which were classified as TDRs and measured using a discounted cash flow methodology. At December 31, 2017 these loans were valued at $68,000 and $8,000, respectively.

22

8.

Fair Value (continued)

 

The following table sets forth the carrying amount and estimated fair valuesvalue of the Corporation’s financial instruments included in the consolidated balance sheet as of September 30, 2018 and December 31, 2017:sheet: 

 

(Dollar amounts in thousands)

                                   
 

Carrying

 

Fair Value Measurements using:

 

Carrying

 

Fair Value Measurements using:

Description

 

Amount

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Amount

 

Total

 

Level 1

 

Level 2

 

Level 3

September 30, 2018:

               

September 30, 2019:

                    

Financial Assets:

                                   

Cash and cash equivalents

 $22,680 $22,680 $22,680 $- $- $49,302  $49,302  $49,302  $  $ 

Securities-available for sale

  97,509  97,509  4,395  89,614  3,500

Securities-equities

  473  473  473  -  -

Interest earning time deposits

  10,198   10,198      10,198    

Securities - available-for-sale

  117,899   117,899   4,026   110,373   3,500 

Securities - equities

  23   23   23       

Loans held for sale

  120  120  -  120  -  154   154      154    

Loans, net

  592,125  583,741  -  -  583,741  688,357   682,392         682,392 

Federal bank stock

  4,466  N/A  N/A  N/A  N/A  5,856   N/A   N/A   N/A   N/A 

Accrued interest receivable

  2,302  2,302  88  353  1,861  2,754   2,754   122   442   2,190 
Total $719,675 $706,825 $27,636 $90,087 $589,102 $874,542  $862,722  $53,473  $121,167  $688,082 

Financial Liabilities:

                                   

Deposits

  682,361  685,333  513,011  172,322  -  808,025   814,778   580,820   233,958    

Borrowed funds

  19,800  19,414  -  19,414  -  33,800   34,417      34,417    

Accrued interest payable

  460  460  38  422  -  652   652   50   602    
Total $702,621 $705,207 $513,049 $192,158 $- $842,477  $849,847  $580,870  $268,977  $ 

 

 

Carrying

 

Fair Value Measurements using:

 

Carrying

 

Fair Value Measurements using:

 

Amount

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Amount

 

Total

 

Level 1

 

Level 2

 

Level 3

December 31, 2017:

               

December 31, 2018:

                    

Financial Assets:

                                   

Cash and cash equivalents

 $14,374 $14,374 $14,374 $- $- $10,955  $10,955  $10,955  $  $ 

Securities-available for sale

  99,350  99,350  4,472  86,880  7,998

Securities-equities

  1,817  1,817  1,683  -  134

Interest earning time deposits

  6,738   6,738      6,738    

Securities - available-for-sale

  97,718   97,718   4,445   89,773   3,500 

Securities - equities

  7   7   7       

Loans held for sale

  504  504  -  504  -               

Loans, net

  577,234  577,616  -  -  577,616  708,664   702,747         702,747 

Federal bank stock

  4,662  N/A  N/A  N/A  N/A  6,351   N/A   N/A   N/A   N/A 

Accrued interest receivable

  2,217  2,217  59  338  1,820  2,570   2,570   63   351   2,156 
Total $700,158 $695,878 $20,588 $87,722 $587,568 $833,003  $820,735  $15,470  $96,862  $708,403 

Financial Liabilities:

                                   

Deposits

  654,643  657,414  483,956  173,458  -  761,546   767,009   539,946   227,063    

Borrowed funds

  26,000  25,499  -  25,499  -  45,350   44,869      44,869    

Accrued interest payable

  413  413  23  390  -  495   495   30   465    
Total $681,056 $683,326 $483,979 $199,347 $- $807,391  $812,373  $539,976  $272,397  $ 

 

This information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation's assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation's disclosures and those of other companies may not be meaningful.

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Table of Contents

 

 

9.8.

Regulatory Matters

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

In 2015,2018 the Board of Governors of the Federal Reserve System amended its Small Bank Holding Company Policy Statement by increasing the policy’s consolidated assets threshold from $500 million$1 billion to $1$3 billion. The primary benefit of being deemed a "small bank holding company" is the exemption from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level.

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (BASEL III rules) became effective for the Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in byon January 1, 2019. Under the BASEL III rules, the Bank must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer is beingwas phased in from 0.0% for 2015 to 2.50% byin 2019. The capital conservation buffer for 2019 is 2.50% and for 2018 iswas 1.875% and was 1.25% for 2017 and 0.625% for 2016. The net unrealized gain or loss on available for sale securities is. Amounts recorded to accumulated other comprehensive income are not included in computing regulatory capital. Management believes as of September 30, 2018,2019, the Bank meetsmet all capital adequacy requirements to which they areit was subject.

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At September 30, 2018,2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution's category.

 

The following table sets forth certain information concerning the Bank’s regulatory capital as of the dates presented. The capital adequacy ratios disclosed below are exclusive of the capital conservation buffer. 

 

(Dollar amounts in thousands) 

September 30, 2018

 

December 31, 2017

 

September 30, 2019

 

December 31, 2018

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

Total capital to risk-weighted assets:

                            

Actual

 $66,711  13.22% $64,221  12.96% $79,681   13.78% $76,344   12.93%

For capital adequacy purposes

  40,381  8.00%  39,630  8.00%  46,243   8.00%  47,252   8.00%

To be well capitalized

  50,476  10.00%  49,537  10.00%  57,804   10.00%  59,065   10.00%

Tier 1 capital to risk-weighted assets:

                            

Actual

 $60,401  11.97% $58,088  11.73% $73,172   12.66% $69,836   11.82%

For capital adequacy purposes

  30,286  6.00%  29,722  6.00%  34,682   6.00%  35,439   6.00%

To be well capitalized

  40,381  8.00%  39,630  8.00%  46,243   8.00%  47,252   8.00%

Common Equity Tier 1 capital to risk-weighted assets:

                            

Actual

 $60,401  11.97% $58,088  11.73% $73,172   12.66% $69,836   11.82%

For capital adequacy purposes

  22,714  4.50%  22,292  4.50%  26,012   4.50%  26,579   4.50%

To be well capitalized

  32,809  6.50%  32,199  6.50%  37,573   6.50%  38,393   6.50%

Tier 1 capital to average assets:

                            

Actual

 $60,401  7.90% $58,088  7.71% $73,172   8.13% $69,836   7.95%

For capital adequacy purposes

  30,574  4.00%  30,117  4.00%  35,990   4.00%  35,126   4.00%

To be well capitalized

  38,218  5.00%  37,647  5.00%  44,987   5.00%  43,908   5.00%

 

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10.9.

Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the three months ended September 30, 20182019 and 20172018 and summarizes the significant amounts reclassified out of each component of accumulated other comprehensive income:

 

(Dollar amounts in thousands)

 

Unrealized Gains

 

Defined

    

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

 

and Losses on

 

Benefit

   
 

Available-for-Sale

 

Pension

   
 

Securities

 

Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at July 1, 2018

 $(2,117) $(4,839) $(6,956)

Accumulated Other Comprehensive Income (Loss) at July 1, 2019

 $267  $(4,840) $(4,573)

Other comprehensive income before reclassification

  (447)  -  (447)  130      130 

Amounts reclassified from accumulated other comprehensive income (loss)

  3  -  3  (33)     (33)

Net current period other comprehensive income

  (444)  -  (444)

Accumulated Other Comprehensive Income (Loss) at September 30, 2018

 $(2,561) $(4,839) $(7,400)

Net current period other comprehensive income (loss)

  97      97 

Accumulated Other Comprehensive Income (Loss) at September 30, 2019

 $364  $(4,840) $(4,476)

(Dollar amounts in thousands)

 

Amount Reclassified

 
Details about Accumulated Other Comprehensive Loss Components from Accumulated Other Comprehensive Income For the three months ended September 30, 2019Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

 $(42)

Net gain on sale of available-for-sale securities

Tax effect

  9 

Provision for income taxes

Total reclassifications for the period

 $(33)

Net of tax


(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at July 1, 2018

 $(2,117) $(4,839) $(6,956)

Other comprehensive income before reclassification

  (446)     (446)

Amounts reclassified from accumulated other comprehensive income (loss)

  2      2 

Net current period other comprehensive income (loss)

  (444)     (444)

Accumulated Other Comprehensive Income (Loss) at September 30, 2018

 $(2,561) $(4,839) $(7,400)

 

 

(Dollar amounts in thousands)

Amount Reclassified

from Accumulated

Other Comprehensive

Income

Affected Line Item in the

Details about Accumulated Other

For the three months

Statement Where Net

Comprehensive Income Components

ended September 30, 2018

Income is Presented

Unrealized gains and losses on available-for-sale securities

$(4)

Net gain on sale of available-for-sale securities

Unrealized gains and losses on available-for-sale securities

-

Other than temporary impairment losses

1

Provision for income taxes

Total reclassifications for the period

$(3)

Net of tax


(Dollar amounts in thousands)

 

Unrealized Gains

 

Defined

   
  

and Losses on

 

Benefit

   
  

Available-for-Sale

 

Pension

   
  

Securities

 

Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at July 1, 2017

 $(307) $(3,812) $(4,119)

Other comprehensive income before reclassification

  153  -  153

Amounts reclassified from accumulated other comprehensive income (loss)

  -  -  -

Net current period other comprehensive income

  153  -  153

Accumulated Other Comprehensive Income (Loss) at September 30, 2017

 $(154) $(3,812) $(3,966)

(Dollar amounts in thousands)

 

Amount Reclassified

 
Details about Accumulated Other Comprehensive Loss Components from Accumulated Other Comprehensive Income For the three months ended September 30, 2018Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

 $2 

Net loss on sale of available-for-sale securities

Tax effect

   

Provision for income taxes

Total reclassifications for the period

 $2 

Net of tax


 

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10.9.

Accumulated Other Comprehensive Income (Loss)(continued)

(Dollar amounts in thousands)

Amount Reclassified

from Accumulated

Other Comprehensive

Income

Affected Line Item in the

Details about Accumulated Other

For the three months

Statement Where Net

Comprehensive Loss Components

ended September 30, 2017

Income is Presented

Unrealized gains and losses on available-for-sale securities

$-

Net gain on sale of available-for-sale securities

$-

Other than temporary impairment losses

-

Provision for income taxes

Total reclassifications for the period

$-

Net of tax


 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the nine months ended September 30, 20182019 and 20172018 and summarizedsummarizes the significant amounts reclassified out of each component of accumulated other comprehensive income:

 

(Dollar amounts in thousands)

 

Unrealized Gains

 

Defined

    

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

 

and Losses on

 

Benefit

   
 

Available-for-Sale

 

Pension

   
 

Securities

 

Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at January 1, 2018

 $(679) $(4,839) $(5,518)

Accumulated Other Comprehensive Income (Loss) at January 1, 2019

 $(1,517) $(4,840) $(6,357)

Other comprehensive income before reclassification

  (1,722)  -  (1,722)  1,915      1,915 

Amounts reclassified from accumulated other comprehensive income (loss)

  27  -  27  (34)     (34)

Net current period other comprehensive income

  (1,695)  -  (1,695)  1,881      1,881 

Cumulative effect of adoption of ASU 2016-01

  (187)  -  (187)

Accumulated Other Comprehensive Income (Loss) at September 30, 2018

 $(2,561) $(4,839) $(7,400)

Accumulated Other Comprehensive Income (Loss) at September 30, 2019

 $364  $(4,840) $(4,476)

 

(Dollar amounts in thousands)

Amount Reclassified

from Accumulated

Other Comprehensive

Income

Affected Line Item in the

Details about Accumulated Other

For the nine months

Statement Where Net

Comprehensive Income Components

ended September 30, 2018

Income is Presented

Unrealized gains and losses on available-for-sale securities

$(34)

Net gain on sale of available-for-sale securities

Unrealized gains and losses on available-for-sale securities

-

Other than temporary impairment losses

7

Provision for income taxes

Total reclassifications for the period

$(27)

Net of tax

(Dollar amount in thousands)

 

Amount Reclassified

 
Details about Accumulated Other Comprehensive Income Components from Accumulated Other Comprehensive Income For the Nine Months Ended September 30, 2019Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

 $(43)

Net gain on sale of available-for-sale securities

Tax effect

  9 

Provision for income taxes

Total reclassifications for the period

 $(34)

Net of tax


 

(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at January 1, 2018

 $(679) $(4,839) $(5,518)

Cumulative effect of change in accounting principle for marketable equity securities, net of tax

  (187)     (187)

Accumulated Other Comprehensive Income (Loss) at January 1, 2018, as adjusted

 $(866) $(4,839) $(5,705)
             

Other comprehensive income before reclassification

  (1,702)     (1,702)

Amounts reclassified from accumulated other comprehensive income (loss)

  7      7 

Net current period other comprehensive income

  (1,695)     (1,695)
             

Accumulated Other Comprehensive Income (Loss) at September 30, 2018

 $(2,561) $(4,839) $(7,400)

26

(Dollar amount in thousands)

 

Amount Reclassified

 
Details about Accumulated Other Comprehensive Income Components from Accumulated Other Comprehensive Income For the Nine Months Ended September 30, 2018Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

 $9 

Net loss on sale of available-for-sale securities

Tax effect

  (2)

Provision for income taxes

Total reclassifications for the period

 $7 

Net of tax

24

Table of Contents

 

(Dollar amounts in thousands)

 

Unrealized Gains

 

Defined

   
  

and Losses on

 

Benefit

   
  

Available-for-Sale

 

Pension

   
  

Securities

 

Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at January 1, 2017

 $(679) $(3,812) $(4,491)

Other comprehensive income before reclassification

  421  -  421

Amounts reclassified from accumulated other comprehensive income (loss)

  104  -  104

Net current period other comprehensive income

  525  -  525

Accumulated Other Comprehensive Income (Loss) at September 30, 2017

 $(154) $(3,812) $(3,966)

(Dollar amounts in thousands)

 

Amount Reclassified

  
  

from Accumulated

  
  

Other Comprehensive

  
  

Income

 

Affected Line Item in the

Details about Accumulated Other

 

For the nine months

 

Statement Where Net

Comprehensive Income Components

 

ended September 30, 2017

 

Income is Presented

Unrealized gains and losses on available-for-sale securities

 $350 

Net gain on sale of available-for-sale securities

Unrealized gains and losses on available-for-sale securities

  (508) 

Other than temporary impairment losses

   54 

Provision for income taxes

Total reclassifications for the period

 $(104) 

Net of tax


 

11.10.

Revenue Recognition

 

On January 1, 2018, the Corporation adopted ASU 2014-09 "Revenue from Contracts with Customers" (Topic 606) and all subsequent ASUs that modified Topic 606. Interest income, net securities gains (losses) and bank-owned life insurance are not included within the scope of Topic 606. For the revenue streams in the scope of Topic 606, service charges on deposits and electronic banking fees, there are no significant judgments related to the amount and timing of revenue recognition. All of the Corporation's revenue from contracts with customers is recognized within noninterest income.

 

Service charges on deposits: The Corporation earns fees from its deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which include services such stop payment charges, statement rendering and other fees, are recognized at the time the transaction is executed as that is the point in time the Corporation fulfills the customer's request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Corporation satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer's account balance.

 

Electronic banking fees: The Corporation earns interchange and other ATM related fees from cardholder transactions conducted through the various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The gross amount of these fees are processed through noninterest income. Other fees, such a transaction surcharges and card replacement fees are withdrawn from the customer's account balance at the time of service.

 

27

The following table presents the Corporation's sources of noninterest income for the three and nine months ended September 30, 20182019 and 2017:2018.

 

(Dollar amounts in thousands)

 

Three months ended

 

Nine months ended

 For the three months ended September 30, For the nine months ended September 30,
 

September 30,

 

September 30,

 

2019

 

2018

 

2019

 

2018

 

2018

 

2017

 

2018

 

2017

Non Interest Income

            

Noninterest income

                

In-scope of Topic 606:

                            

Service charges on deposits

                            

Maintenance fees

 $38 $40 $114 $118 $51  $38  $134  $114 

Overdraft fees

  417  341  1,100  965  403   417   1,253   1,100 

Other fees

  73  66  214  207  76   73   235   214 

Electronic banking fees

  327  292  971  855  384   327   1,079   971 

Noninterest income (in-scope of Topic 606)

  855  739  2,399  2,145  914   855   2,701   2,399 
Noninterest income (out-of-scope of Topic 606)  207  1,535  610  1,851

Noninterest income (out-of-scope of Topic 606)(1)

  295   207   695   610 
Total noninterest income $1,062 $2,274 $3,009 $3,996 $1,209  $1,062  $3,396  $3,009 

 

(1)

Noninterest income items that are out-of-scope include net realized gains (losses) on sales of securities, net gains (losses) on sales of loans, earnings on bank-owned life insurance and certain other noninterest income items.

 

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11.

Leases

Effective January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842).  As of September 30, 2019, the Corporation leases real estate for five branch offices under various operating lease agreements. The lease agreements have maturity dates ranging from August 2025 to December 2056, including all extension periods. The Corporation has assumed that there are currently no circumstances in which the leases would be terminated before exhausting all options for extensions.  The weighted average remaining life of the lease term for these leases was 13.14 years as of September 30, 2019.

The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption.  This methodology will be continued for the commencement of any subsequent lease agreements.  The weighted average discount rate for the leases was 3.48% as of September 30, 2019.

The total operating lease costs were $48,000 and $145,000, respectively, for the three and nine months ended September 30, 2019.  The right-of-use asset, included in premises and equipment, and lease liability, included in other liabilities, was $1.5 million and $1.7 million, respectively, as of September 30, 2019.  Rental expense for operating leases classified under ASC 840 for the three and nine months ended September 30, 2018 was $50,000 and $150,000, respectively.

Total estimated rental commitments for the operating leases were as follows as of September 30, 2019:

(Dollar amounts in thousands)

    

Year ending December 31:

    

2019 (excluding nine months)

 $53 

2020

  212 

2021

  217 

2022

  222 

2023

  222 

Thereafter

  1,289 

Total minimum lease payments

  2,215 

Discount effect of cash flows

  (470)

Present value of lease liabilities

 $1,745 

26

 

12.

Recent Accounting Pronouncements (continued)

 

Newly Issued Not Yet Effective Accounting Standards

In February 2016, the FASB issued ASU 2016-02 "Leases". This ASU requires lessees to record most leases on their balance sheet but recognize expenses in the income statement in a manner similar to current accounting treatment. This ASU changes the guidance on sale-leaseback transactions, initial direct costs and lease execution costs, and, for lessors, modifies the classification criteria and the accounting for sales-type and direct financing leases. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods therein. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Corporation has analyzed data on leased assets and purchased software to manage lease accounting. The adoption of this guidance is expected to increase both assets and liabilities, but is not expected to have a material impact on the consolidated statement of income.

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. ASU 2016-13 significantly changes the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of the financial instruments. The main provisions of the guidance include (1) replacing the “incurred loss” approach under current GAAP with an “expected loss” model for instruments measured at amortized cost, (2) requiring entities to record an allowance for available-for-sale debt securities rather than reduce the carrying amount of the investments, as is required by the other-than-temporary impairment model under current GAAP, and (3) a simplified accounting model for purchased credit-impaired debt securities and loans. The ASU is effective for interim and annual reporting periods beginning after December 15, 2019, although early adoption is permitted. Management has selected a software vendor and is currently inworking through the developmental stages of collectingimplementation process.  The Corporation is reviewing available historical information in order to assess the expected credit losses and determine the impact of the adoption of ASU 2016-13 on the Corporation's financial statements.

28

this ASU for smaller reporting companies until fiscal years beginning after December 15, 2022. The guidance is required to be applied using the modified retrospective approach.  As the Corporation is a smaller reporting company, the delay would be applicable.

12.

Recent Accounting Pronouncements (continued)

 

In January 2017, FASB ASU 2017-04, "Simplifying the Test for Goodwill Impairment". This ASU simplifies the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Instead, under this amendment, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. The amendments are effective for public business entities for the first interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Corporation has goodwill from prior business combinations and performs an annual impairment test or more frequently if changes or circumstances occur that would more likely than not reduce the fair value of the reporting unit below its carrying value. The Corporation's most recent annual impairment assessment determined that the Corporation's goodwill was not impaired. Although the Corporation cannot anticipate future goodwill impairment assessments, based on the most recent assessment it is unlikely that an impairment amount would need to be calculated and, therefore, does not anticipate a material impact from these amendments to the Corporation's financial position and results of operations. The current accounting policies and processes are not anticipated to change, except for the elimination of the Step 2 analysis.

 

Adoption of New Accounting Policies

In February 2016, the FASB issued ASU 2016-02 "Leases". This ASU requires lessees to record most leases on their balance sheet but recognize expenses in the income statement in a manner similar to current accounting treatment. This ASU changes the guidance on sale-leaseback transactions, initial direct costs and lease execution costs, and, for lessors, modifies the classification criteria and the accounting for sales-type and direct financing leases. ASU 2016-02 was effective for annual periods beginning after December 15, 2018, and interim periods therein. In January 2018, the FASB issued ASU 2018-01, which allows entities the option to apply the provisions of the new lease guidance at the effective date without adjusting the comparative periods presented. Adoption of this guidance as of January 1, 2019 resulted in the recording of operating lease right-of-use assets of $1.6 million and operating lease liabilities of $1.8 million.  The Corporation recorded a cumulative adjustment to retained earning for prior periods of $170,000, net of deferred taxes of $45,000.  See Note 11-Leases for more information.

In March 2017, the FASB issued ASU 2017-08, “Receivable - Nonrefundable Fees and Other Costs (Subtopic 310-20) Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 amends guidance on the amortization period of premiums on certain purchased callable debt securities to shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments are effective for public business entities for fiscal years beginning after December 15, 2019,2018, and interim periods within fiscal years beginning after December 15, 2020. Earlytherein.  The adoption of this guidance on January 1, 2019 resulted in a cumulative adjustment to retained earnings of $10,000, net of deferred taxes of $3,000, for the prior periods. The remaining securities subject to this guidance have a call date one month prior to maturity, therefore the impact to the statement of income in subsequent periods is permitted, including adoption in an interim period. The Corporation is currently evaluating the potential impact of ASU 2017-08 on its financial statements and disclosures.immaterial.

 

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." The amendments in this Update are to better reflect the economic results of hedging in the financial statements along with simplification of certain hedge accounting requirements. Specifically, the entire change in the fair value of the hedging instrument is required to be presented in the same income statement line as and in the same period that the earnings effect of the hedged item is recognized. Therefore, hedge ineffectiveness will not be reported separately or in a different period. In addition, hedge effectiveness can be determined qualitatively in periods following inception. The amendments permit an entity to measure the change in fair value of the hedged item on the basis of the benchmark rate component. They also permit an entity to measure the hedged item in a partial-term fair value hedge of interest rate risk by assuming the hedged item has a term that reflects only the designated cash flows being hedged. For a closed portfolio of prepayable financial assets, an entity is permitted to designate the amount that is not expected to be affected by prepayments or defaults as the hedged item. For public business entities, the new guidance iswas effective for fiscal years beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. The Corporation is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

In August 2018, the FASB issued ASU 2018-13 "Fair Value Measurement".  ASU 2018-13 eliminates, adds and modifies certain disclosure requirements for fair value measurements.  Disclosures for transfers between Level 1 and Level 2, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurement will be removed.  Additional disclosures will be required relating to (a) changes in unrealized gains/losses in OCI for Level 3 fair value measurements for assets held at the end of the reporting period, and (b) the process of calculating weighted average for significant unobservable inputs used to develop Level 3 fair value measurements.  The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.  Early adoption is permitted.  The Corporation is currently evaluating the potential impact of ASU 2018-13 on its financial statements and disclosures.

In August 2018, the FASB issued ASU 2018-14 "Compensation - Retirement Benefits - Defined Benefit Plans".  ASU 2018-14 removes disclosures pertaining to (a) the amounts of AOCI expected to be recognized as pension costs over the next fiscal year, (b) the amount and timing of plan assets expected to be returned to the employer, and (c) the effect of one-percentage-point change in the assumed health care trends on (i) service and interest costs and (ii) post-retirement health care benefit obligation.  A disclosure will be added requiring an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period.  The amendments in this update are effective retrospectively for annual periods and interim periods within those annual periods beginning after December 15, 2020.  Early adoption is permitted.  The Corporation is currently evaluating the potential impact of ASU 2018-14 on its financial statements and disclosures.

Adoption of New Accounting Policies

In March 2017, the FASB issued ASU 2017-07, "Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." The amendments in this update require that an employer disaggregate the service cost component from the other components of net benefit cost. The amendments also provide explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement and allow only the service cost component of net benefit cost to be eligible for capitalization. The amendments in this update improve the consistency, transparency, and usefulness of financial information to users that have communicated that the service cost component generally is analyzed differently from the other components of net benefit cost. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The adoption of the new guidance diddoes not have a materialderivative or hedging instruments so this guidance had no impact on the consolidated financial statements.

 

29

12.

Recent Accounting Pronouncements (continued)

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-9 “Revenue from Contracts with Customers”. ASU 2014-9 provides guidance that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The guidance does not apply to revenue associated with financial instruments, including loans and securities. The Corporation has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. The Corporation has evaluated revenue streams within noninterest income to assess the applicability of this guidance and determined that service charges on deposits and electronic banking fees within the scope of this ASU. Because performance obligations are satisfied as services are rendered and the fees are fixed, there is little judgment involved in applying the guidance that significantly affects the determination of the amount and timing of revenue from contracts with customers. The adoption of this guidance on January 1, 2018 did not have a material impact on the Corporation's financial statements.  See Note 11 for further detail related to the adoption of this standard.

In January 2016, the FASB issued ASU 2016-1 “Recognition and Measurement of Financial Assets and Financial Liabilities”. ASU 2016-1 revises the accounting for the classification and measurement of investments in equity securities and revises the presentation of certain fair value changes for financial liabilities measured at fair value. For equity securities, the guidance in ASU 2016-1 requires equity investments to be measured at fair value with changes in fair value recognized in net income. For financial liabilities that are measured at fair value in accordance with the fair value option, the guidance requires presenting in other comprehensive income the change in fair value that relates to a change in instrument-specific credit risk. ASU 2016-1 also eliminates the disclosure assumptions used to estimate fair value for financial instruments measured at amortized cost and requires disclosure of an exit price notion in determining the fair value of financial instruments measured at amortized cost. ASU 2016-1 was effective for interim and annual periods beginning after December 15, 2017. The adoption of ASU 2016-1 did not have a significant impact on the Corporation's financial statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force)”. ASU 2016-15 clarifies the presentation of specific types of cash flow receipts and payments, including the payment of debt prepayment or debt extinguishment costs, contingent consideration cash payments paid subsequent to the acquisition date and proceeds from settlement of BOLI policies. This guidance was effective for fiscal years beginning after December 15, 2017. The adoption of ASU 2016-15 did not have an impact the Corporation's financial statements and disclosures.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This section discusses the consolidated financial condition and results of operations of Emclaire Financial Corp and its wholly owned subsidiaries for the three and nine months ended September 30, 2018,2019, compared to the same periods in 20172018 and should be read in conjunction with the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017,2018, filed with the SEC and with the accompanying consolidated financial statements and notes presented in this Form 10-Q.

 

This Form 10-Q, including the financial statements and related notes, contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” or words or phrases of similar meaning. We caution that the forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performances or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements. Therefore, we caution you not to place undue reliance on our forward looking information and statements. Except as required by applicable law or regulation, we will not update the forward looking statements to reflect actual results or changes in factors affecting the forward looking statements.

 

CHANGES IN FINANCIAL CONDITION

 

Total assets increased $22.7$42.6 million, or 4.7%, to $772.8$941.4 million at September 30, 20182019 from $750.1$898.9 million at December 31, 2017. Asset growth2018. The change in assets was driven primarily by increasesan increase in cash and cash equivalents, securities and interest earning time deposits of $38.3 million, $20.2 million and $3.5 million, respectively, partially offset by a decrease in net loans receivable of $8.3 million and $14.9 million, respectively.$20.3 million. Total liabilities increased $22.2$36.6 million, or 4.5%, to $713.2$855.5 million at September 30, 20182019 from $691.0$818.9 million at December 31, 2017, resulting2018 primarily from a $27.7 million, or 4.2%,due to an increase in customer deposits of $46.5 million, partially offset by a $6.2 million decrease in borrowed funds. Deposit growth consistedfunds of a $20.7 million, or 3.9%, increase in interest bearing deposits and a $7.0 million, or 5.6%, increase in non-interest bearing deposits.$11.6 million.

 

Stockholders’ equity increased $519,000$5.9 million, or 7.4%, to $59.6$85.9 million at September 30, 20182019 from $59.1$80.0 million at December 31, 20172018 primarily due to a $2.2$3.8 million increase in retained earnings as a result of $3.9$6.3 million of net income, partially offset by $1.9$2.4 million of common dividends paid, and a $1.9 million decrease inpaid.  Additionally, the accumulated other comprehensive income.loss declined by $1.9 million as a result of improvement in the Corporation unrealized gains on securities.  The Corporation remains well capitalized and is positioned for continued growth with total stockholders’ equity at 7.7%9.1% of total assets.  Tangible bookBook value per common share was $21.59$30.28 at September 30, 2018,2019, compared to $21.28$28.09 at December 31, 2017.

2018

At September 30, 2018,2019, the Bank was considered “well-capitalized” with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 7.90%8.13%, 11.97%12.66%, 11.97%12.66% and 13.22%13.78%, respectively. The Bank was also considered “well-capitalized” at December 31, 20172018 with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 7.71%7.95%, 11.73%11.82%, 11.73%11.82% and 12.96%12.93%, respectively.

RESULTS OF OPERATIONS

 

Comparison of Results for the Three Months Ended September 30, 20182019 and 20172018

 

General. Net income decreased $546,000,available to common stockholders increased $1.0 million, or 32.0%86.7%, to $1.2$2.2 million or $0.51 per common share, for the three months ended September 30, 20182019 from $1.7$1.2 million or $0.77 per common share, for the same period in 2017.2018. This decreaseincrease was the result of a $1.2 million decreaseincreases in net interest income and noninterest income of $875,000 and increases$147,000, respectively, and a decrease of $445,000 in noninterest expense and the provision for loan losses, of $113,000 and $30,000, respectively, partially offset by a $604,000 increase in net interest income and a decrease of $205,000increases in the provision for income taxes.taxes and noninterest expense of $257,000 and $203,000, respectively.

 

Net interest income. Tax equivalent net interest income increased $519,000,$872,000, or 9.2%14.1%, to $7.1 million for the three months ended September 30, 2019 from $6.2 million for the three months ended September 30, 2018 from $5.7 million for the three months ended September 30, 2017.. This increase was attributed to an increase in tax equivalent interest income of $697,000,$1.7 million, partially offset by an increase in interest expense of $179,000.

$846,000.

Interest income. Tax equivalent interest income increased $697,000,$1.7 million, or 10.2%22.9%, to $7.5$9.2 million for the three months ended September 30, 20182019 from $6.8$7.5 million for the same period in 2017.2018. This increase was attributed to increases in interest earned on loans, securities and interest-earning deposits with banks and securities and dividends on federal bank stocks of $664,000, $18,000$1.5 million, $139,000, $52,000 and $14,000,$39,000, respectively.

 

Tax equivalent interest earned on loans receivable increased $664,000,$1.5 million, or 11.0%22.2%, to $6.7$8.2 million for the three months ended September 30, 20182019 compared to $6.1$6.7 million for the same period in 2017.2018. This increase resulted from a $37.5$100.9 million, or 6.7%17.0%, increase in average loans, accounting for ana $1.2 million increase of $418,000 in interest income. The increase in loans receivable was related to the acquisition of Northern Hancock Bank and Trust Co. (Northern Hancock)Community First Bancorp, Inc. in September 2017 and strong loan growth achieved in late 2017 and the first nine months ofOctober 2018. Adding to this favorable volume variance, the average yield on loans increased 1720 basis points to 4.48%4.68% for the three months ended September 30, 2018,2019, versus 4.31%4.48% for the same period in 2017.2018. This favorable yield variance accounted for a $246,000$307,000 increase in interest income. Accretion of purchase accounting adjustments on acquired loans accounted for approximately 5 basis points of the yield increase.

 

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Interest earned on deposits with banks increased $139,000 to $251,000 for the three months ended September 30, 2019 compared to $112,000 for the same period in 2018. This increase resulted from a $25.2 million, or 98.2%, increase in average cash balances, accounting for a $123,000 increase in interest income.  Adding to this favorable volume variance, the average yield on cash and cash equivalent balances increased 23 basis points to 1.96% for the three months ended September 30, 2019, versus 1.73% for the same period in 2018, accounting for a $16,000 increase in interest income.

Tax equivalent interest earned on securities increased $18,000,$52,000, or 3.0%8.4%, to $622,000$674,000 for the three months ended September 30, 20182019 compared to $604,000$622,000 for the same period in 2018. The average balance of securities increased $4.3 million, or 4.3%, accounting for a $27,000 increase in interest income.  Additionally, the average yield on securities increased by 10 basis points to 2.58% for the three months ended September 30, 2017. This increase resulted from a 12 basis point increase in the average yield on securities to2019 versus 2.48% for the three months ended September 30, 2018 versus 2.36% for the same period in 2017.2018. This favorable yield variance accounted for a $30,000$25,000 increase in interest income. Partially offsetting this favorable variance, the average balance of securities decreased $2.0 million, accounting for a $12,000 decrease in interest income.

 

Interest earnedDividends on deposits with banksfederal bank stocks increased $14,000,$39,000, or 14.3%60.0%, to $112,000$104,000 for the three months ended September 30, 2018 compared to $98,0002019 from $65,000 for the same period in 2018. This increase was primarily due to a $1.4 million, or 30.5%, increase in the average balance of federal bank stocks, accounting for a $22,000 increase in interest income.  Additionally, an increase of 131 basis points in the average yield on federal bank stocks to 7.10% for the three months ended September 30, 2017. This increase resulted from a 57 basis point2019, versus 5.79% for the same period in 2018, accounted for an $17,000 increase in the average yield on these accountsinterest income.

Interest expense. Interest expense increased $846,000, or 63.8%, to 1.73%$2.2 million for the three months ended September 30, 2018, versus 1.16% for the same period in 2017, accounting for a $41,000 increase in interest income. Partially offsetting this favorable variance, the average balance of interest-earning deposits decreased $7.8 million, or 23.4%, accounting for a decrease of $27,000 in interest income.

Interest expense. Interest expense increased $179,000, or 15.6%, to2019 from $1.3 million for the three months ended September 30, 2018 from $1.1 million for the same period in 2017.2018. This increase in interest expense can be attributed to a $359,000 increaseincreases in interest incurred on deposits partially offset by a decreaseand borrowed funds of $180,000 in interest incurred on borrowed funds.$755,000 and $91,000, respectively.

 

Interest expense incurred on deposits increased $359,000,$755,000, or 43.6%63.8%, to $1.9 million for the three months ended September 30, 2019 compared to $1.2 million for the three months ended September 30, 2018 compared to $824,000 for the same period in 2017.2018. The average cost of interest-bearing deposits increased 2235 basis points to 0.86%1.21% for the three months ended September 30, 2018,2019, versus 0.64%0.86% for the same period in 2017,2018, accounting for a $288,000$550,000 increase in interest expense. Additionally, the average balance of interest-bearing deposits increased $40.8$85.4 million, or 8.0%15.6%, to $548.5$633.9 million for the three months ended September 30, 2018,2019, compared to $507.6$548.5 million for the same period in 20172018 causing a $71,000$205,000 increase in interest expense. This increase was primarily due to the acquisition of Northern HancockCommunity First in September 2017 and strong deposit growth during late 2017 and the first nine months ofOctober 2018.

 

Interest expense incurred on borrowed funds decreased $180,000,increased $91,000, or 55.9%64.1%, to $142,000$233,000 for the three months ended September 30, 2018,2019, compared to $322,000$142,000 for the same period in the prior year. The average balance of borrowed funds decreased $21.5increased $14.0 million, or 52.0%70.7%, to $19.8$33.8 million for the three months ended September 30, 2018,2019, compared to $41.3$19.8 million for the same period in 20172018 causing a $143,000 decreasean $90,000 increase in interest expense. The reductionincrease in the outstanding balance of borrowed funds primarily resulted from the payoff of maturing FHLB long-term notes of $15.0 million in November 2017 and the early payoff of athree additional $5.0 million FHLB long-term notenotes taken in FebruaryDecember 2018. In addition, theThe average cost of long-term borrowed funds decreased 28increased 12 basis points to 2.82%2.54% for the three months ended September 30, 20182019 compared to 3.10%2.42% for the same period in 20172018 causing a $38,000$5,000 increase in interest expense.  Partially offsetting the cost of long-term borrowings, the average cost of short-term borrowed funds decreased 60 basis points to 5.71% for the three months ended September 30, 2019 compared to 6.31% for the same period in 2018 causing a $4,000 decrease in interest expense.

 

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Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

 

(Dollar amounts in thousands)

 

Three months ended September 30,

  

2018

 

2017

  

Average

    

Yield /

 

Average

    

Yield /

  

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

Interest-earning assets:

                  

Loans, taxable

 $574,904 $6,536  4.51% $532,225 $5,763  4.30%

Loans, tax exempt

  19,294  180  3.70%  24,495  289  4.69%

Total loans receivable

  594,198  6,716  4.48%  556,720  6,052  4.31%

Securities, taxable

  75,759  464  2.43%  75,367  421  2.22%

Securities, tax exempt

  23,733  158  2.65%  26,100  183  2.78%

Total securities

  99,492  622  2.48%  101,467  604  2.36%

Interest-earning deposits with banks

  25,670  112  1.73%  33,512  98  1.16%

Federal bank stocks

  4,453  65  5.79%  4,882  64  5.20%

Total interest-earning cash equivalents

  30,123  177  2.33%  38,394  162  1.67%

Total interest-earning assets

  723,813  7,515  4.12%  696,581  6,818  3.88%

Cash and due from banks

  2,940        2,720      

Other noninterest-earning assets

  46,375        45,308      

Total Assets

 $773,128       $744,609      

Interest-bearing liabilities:

                  

Interest-bearing demand deposits

 $379,544 $502  0.52% $340,771 $314  0.37%

Time deposits

  168,933  681  1.60%  166,872  510  1.21%

Total interest-bearing deposits

  548,477  1,183  0.86%  507,643  824  0.64%

Borrowed funds, short-term

  2,050  33  6.31%  2,500  28  4.50%

Borrowed funds, long-term

  17,753  109  2.42%  38,766  294  3.01%

Total borrowed funds

  19,803  142  2.84%  41,266  322  3.10%

Total interest-bearing liabilities

  568,280  1,325  0.93%  548,909  1,146  0.83%

Noninterest-bearing demand deposits

  134,183  -  -  128,254  -  -

Funding and cost of funds

  702,463  1,325  0.75%  677,163  1,146  0.67%

Other noninterest-bearing liabilities

  10,733        10,061      

Total Liabilities

  713,196        687,224      

Stockholders' Equity

  59,932        57,385      

Total Liabilities and Stockholders' Equity

 $773,128       $744,609      

Net interest income

    $6,190       $5,672   
                   

Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)

        3.19%        3.05%
                   

Net interest margin (net interest income as a percentage of average interest-earning assets)

        3.39%        3.23%

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Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

(Dollar amounts in thousands)

 

Three months ended September 30,

  

2018 versus 2017

  

Increase (Decrease) due to

  

Volume

 

Rate

 

Total

Interest income:

         

Loans

 $418 $246 $664

Securities

  (12)  30  18

Interest-earning deposits with banks

  (27)  41  14

Federal bank stocks

  (6)  7  1

Total interest-earning assets

  373  324  697
          

Interest expense:

         

Interest-bearing deposits

  70  289  359

Borrowed funds, short-term

  (6)  11  5

Borrowed funds, long-term

  (136)  (49)  (185)

Total interest-bearing liabilities

  (72)  251  179

Net interest income

 $445 $73 $518

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

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Table of Contents

Information pertaining to the allowance for loan losses and nonperforming assets for the three months ended September 30, 2018 and 2017 is as follows:

(Dollar amounts in thousands)

 

As of or for the three months ended

  

September 30,

  

2018

 

2017

Balance at the beginning of the period

 $6,118 $5,767

Provision for loan losses

  300  270

Charge-offs

  (76)  (101)

Recoveries

  18  4

Balance at the end of the period

 $6,360 $5,940
       

Nonperforming loans

 $5,488 $3,731

Nonperforming assets

  6,088  4,160

Nonperforming loans to total loans

  0.92%  0.64%

Nonperforming assets to total assets

  0.79%  0.54%

Allowance for loan losses to total loans

  1.06%  1.02%

Allowance for loan losses to non-performing loans

  115.89%  159.21%

Nonperforming loans increased $3.0 million to $5.5 million at September 30, 2018 from $2.5 million at June 30, 2018. This increase was primarily due to a $2.5 million commercial mortgage loan being placed on nonaccrual status based on the deteriorating financial condition of the borrower. Given the estimated value of the borrower's significant real estate holdings, most of which are pledged as collateral for the loan, the Corporation does not currently expect to incur any loss on this loan and the loan continues to pay per its contractual terms. Of the $5.5 million in nonperforming loans, $3.1 million were not 30 days or more past due at September 30, 2018.

As of September 30, 2018, the Corporation’s classified and criticized assets amounted to $14.5 million, or 1.9% of total assets, with $10.6 million classified as substandard and $3.9 million identified as special mention. This compares to classified and criticized assets of $14.3 million, or 1.9% of total assets, with $10.3 million classified as substandard and $4.1 million identified as special mention at June 30, 2018. 

The provision for loan losses increased $30,000, or 11.1%, to $300,000 for the three months ended September 30, 2018 from $270,000 for the same period in 2017 due primarily to general growth in the loan portfolio experienced in the third quarter of 2018.

Noninterest income. Noninterest income decreased $1.2 million, or 53.3%, to $1.1 million for the three months ended September 30, 2018, compared to $2.3 million for the same period in 2017. During the quarter ended September 30, 2017, the Corporation recorded a $1.3 million bargain purchase gain related to the acquisition of NHBT. Partially offsetting this, fees and service charges increased $80,000 as overdraft charges for the three months ended September 30, 2018 outpaced the same period in the prior year and other income increased $28,000 due to increased interchange fee income.

Noninterest expense. Noninterest expense increased $113,000, or 2.1%, to $5.6 million for the three months ended September 30, 2018 compared to $5.4 million for the same period in 2017. This increase in noninterest expense can be attributed primarily to increases in compensation and benefits expense and professional fees of $231,000 and $86,000 respectively, partially offset by a $286,000 decrease in acquisition costs.

Compensation and employee benefits increased $231,000, or 10.1%, to $2.5 million for the three months ended September 30, 2018 compared to $2.3 million for the same period in 2017. This increase was primarily the result of increases in salaries, other compensation and benefits and insurance benefits of $179,000, $39,000 and $33,000, respectively. These increases are primarily related to costs associated with the operation of the new full-service banking office in Chester, West Virginia which was acquired from Northern Hancock, increased health insurance costs and normal salary and benefit increases.

Professional fees increased $86,000, or 54.8%, to $243,000 for the three months ended September 30, 2018 compared to $157,000 for the same period in 2017.  This increase was primarily the result of the addition of new consulting agreements added during the period as compared to 2017.

Acquisition costs decreased $286,000 for the three months ended September 30, 2018 compared to the same period in 2017. Costs related to the acquisition of Community First totaled $677,000 for the three months ended September 30, 2018, while costs related to the acquisition of Northern Hancock totaled $963,000 for the three months ended September 30, 2017.

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Provision for income taxes. The provision for income taxes decreased $205,000, or 52.3%, to $187,000 for the three months ended September 30, 2018 compared to $392,000 for the same period in the prior year. This related to a decrease in net income before taxes and a decrease in the Corporation’s effective tax rate to 13.9% for the three months ended September 30, 2018 compared to 18.7% for the same period in 2017. The decrease in the Corporation's effective tax rate was due to the enactment of the Tax Cuts and Job Act in December 2017 and the reduction of the corporate income tax rate from a maximum of 35% to a flat 21%.

Comparison of Results for the Nine Months Ended September 30, 2018 and 2017

General. Net income increased $231,000, or 6.3%, to $3.9 million, or $1.72 per diluted share, for the nine months ended September 30, 2018 from $3.7 million, or $1.69 per diluted share, for the same period in 2017. This increase was the result of a $2.1 million increase in net interest income and a $243,000 decrease in the provision for income taxes, partially offset by increases in the provision for loan losses and noninterest expense of $347,000 and $796,000, respectively, and a $987,000 decrease in noninterest income.

Net interest income. Tax equivalent net interest income increased $1.9 million, or 11.4%, to $18.3 million for the nine months ended September 30, 2018 from $16.5 million for the nine months ended September 30, 2017. This increase was attributed to an increase in tax equivalent interest income of $2.4 million, partially offset by an increase in interest expense of $487,000.

Interest income. Tax equivalent interest income increased $2.4 million, or 12.0%, to $22.0 million for the nine months ended September 30, 2018 from $19.7 million for the same period in 2017. This increase was attributed to increases in interest earned on loans and interest-earning deposits with banks, dividends on federal bank stocks and interest earned on securities of $2.2 million, $77,000, $42,000 and $27,000, respectively.

Tax equivalent interest earned on loans receivable increased $2.2 million, or 12.6%, to $19.8 million for the nine months ended September 30, 2018 compared to $17.6 million for the same period in 2017. This increase resulted from a $44.3 million, or 8.1%, increase in average loans, accounting for a $1.5 million increase in interest income. The increase in loans receivable was related to the acquisition of Northern Hancock in September 2017 and strong loan growth achieved in late 2017 and the first nine months of 2018. Adding to this favorable volume variance, the average yield on loans increased 18 basis points to 4.48% for the nine months ended September 30, 2018, versus 4.30% for the same period in 2017. This favorable yield variance accounted for a $745,000 increase in interest income. Included in interest earned on loans receivable for the nine months ended September 30, 2018, the Corporation recorded $113,000 of recovered interest related to the payoff of a nonperforming loan relationship totaling $789,000.

Tax equivalent interest earned on securities increased $27,000, or 1.5%, to $1.8 million for the nine months ended September 30, 2018 and September 30, 2017. This increase resulted from a 6 basis point increase in the average yield on securities to 2.44% for the nine months ended September 30, 2018 versus 2.38% for the same period in 2017. This favorable yield variance accounted for a $48,000 increase in interest income. Partially offsetting this favorable variance, the average balance of securities decreased $1.2 million, accounting for a $21,000 decrease in interest income.

Interest earned on deposits with banks increased $77,000, or 51.0%, to $228,000 for the nine months ended September 30, 2018 compared to $151,000 for the nine months ended September 30, 2017. This increase resulted from a 47 basis point increase in the average yield on these accounts to 1.47% for the nine months ended September 30, 2018, versus 1.00% for the same period in 2017, accounting for a $73,000 increase in interest income. Additionally, the average balance of interest-earning deposits increased $485,000, accounting for a increase of $4,000 in interest income.

Dividends on federal bank stocks increased $42,000, or 23.5%, to $221,000 for the nine months ended September 30, 2018 from $179,000 for the same period in 2017. This increase was primarily due to an increase of 172 basis points in the average yield on federal bank stocks to 6.64% for the nine months ended September 30, 2018, versus 4.92% for the same period in 2017, accounting for a $58,000 increase in interest income. The increase in the average yield resulted from recent increases in the dividend rate paid on FHLB stock. Partially offsetting the favorable yield variance, the average balance of federal bank stocks decreased $408,000, or 8.4%, accounting for a $16,000 decrease in interest income.

Interest expense. Interest expense increased $487,000, or 15.1%, to $3.7 million for the nine months ended September 30, 2018 from $3.2 million for the same period in 2017. This increase in interest expense can be attributed to a $1.0 million increase in interest incurred on deposits, partially offset by a decrease of $514,000 in interest incurred on borrowed funds.

Interest expense incurred on deposits increased $1.0 million, or 44.0%, to $3.3 million for the nine months ended September 30, 2018 compared to $2.3 million for the same period in 2017. The average cost of interest-bearing deposits increased 18 basis points to 0.81% for the nine months ended September 30, 2018, versus 0.63% for the same period in 2017, accounting for a $702,000 increase in interest expense. Additionally, the average balance of interest-bearing deposits increased $58.8 million, or 12.1%, to $543.7 million for the nine months ended September 30, 2018, compared to $484.9 million for the same period in 2017 causing a $299,000 increase in interest expense. This increase was primarily due to the acquisition of Northern Hancock in September 2017 and strong deposit growth during late 2017 and the first nine months of 2018.

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Interest expense incurred on borrowed funds decreased $514,000, or 53.9%, to $440,000 for the nine months ended September 30, 2018, compared to $954,000 for the same period in the prior year. The average balance of borrowed funds decreased $20.8 million, or 49.2%, to $21.5 million for the nine months ended September 30, 2018, compared to $42.2 million for the same period in 2017 causing a $422,000 decrease in interest expense. The reduction in the outstanding balance of borrowed funds resulted from the payoff of maturing FHLB long-term notes of $15.0 million in November 2017 and the early payoff of a $5.0 million FHLB long-term note in February 2018. In addition, the average cost of borrowed funds decreased 28 basis points to 2.74% for the nine months ended September 30, 2018 compared to 3.02% for the same period in 2017 causing a $92,000 decrease in interest expense.

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

(Dollar amounts in thousands)

 

Nine months ended September 30,

 

Three Months Ended September 30,

 
 

2018

 

2017

 

Average

    

Yield /

 

Average

    

Yield /

 

2019

  

2018

 
 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

Average Balance

  

Interest

  

Yield/ Rate

  

Average Balance

  

Interest

  

Yield/ Rate

 

Interest-earning assets:

                                          

Loans, taxable

 $569,745 $19,223  4.51% $522,156 $16,747  4.29% $673,970  $7,994   4.71% $574,904  $6,536   4.51%

Loans, tax exempt

  20,661  568  3.68%  23,914  833  4.66%  21,163   210   3.93%  19,294   180   3.70%

Total loans receivable

  590,406  19,791  4.48%  546,070  17,580  4.30%  695,133   8,204   4.68%  594,198   6,716   4.48%

Securities, taxable

  73,705  1,312  2.38%  74,128  1,208  2.18%  90,247   583   2.56%  75,759   464   2.43%

Securities, tax exempt

  25,239  497  2.63%  26,008  574  2.95%  13,511   91   2.68%  23,733   158   2.65%

Total securities

  98,944  1,809  2.44%  100,136  1,782  2.38%  103,758   674   2.58%  99,492   622   2.48%

Interest-earning deposits with banks

  20,763  228  1.47%  20,278  151  1.00%  50,881   251   1.96%  25,670   112   1.73%

Federal bank stocks

  4,461  221  6.64%  4,869  179  4.92%  5,813   104   7.10%  4,453   65   5.79%

Total interest-earning cash equivalents

  25,224  449  2.38%  25,147  330  1.75%  56,694   355   2.48%  30,123   177   2.33%

Total interest-earning assets

  714,574  22,049  4.13%  671,353  19,692  3.92%  855,585   9,233   4.28%  723,813   7,515   4.12%

Cash and due from banks

  2,812        2,684        3,515           2,940         

Other noninterest-earning assets

  46,172        45,882        62,389           46,375         

Total Assets

 $763,558       $719,919       $921,489          $773,128         
                  

Interest-bearing liabilities:

                                          

Interest-bearing demand deposits

 $373,534 $1,375  0.49% $321,177 $685  0.28% $405,051  $712   0.70% $379,544  $502   0.52%

Time deposits

  170,151  1,902  1.49%  163,746  1,591  1.30%  228,869   1,226   2.12%  168,933   681   1.60%

Total interest-bearing deposits

  543,685  3,277  0.81%  484,923  2,276  0.63%  633,920   1,938   1.21%  548,477   1,183   0.86%

Borrowed funds, short-term

  2,817  98  4.64%  5,237  100  2.55%  2,050   29   5.71%  2,050   33   6.31%

Borrowed funds, long-term

  18,661  342  2.45%  37,011  854  3.09%  31,750   204   2.54%  17,753   109   2.42%

Total borrowed funds

  21,478  440  2.74%  42,248  954  3.02%  33,800   233   2.74%  19,803   142   2.84%

Total interest-bearing liabilities

  565,163  3,717  0.88%  527,171  3,230  0.82%  667,720   2,171   1.29%  568,280   1,325   0.93%

Noninterest-bearing demand deposits

  128,590  -  -  127,331  -  -  154,837         134,183       

Funding and cost of funds

  693,753  3,717  0.72%  654,502  3,230  0.66%  822,557   2,171   1.05%  702,463   1,325   0.75%

Other noninterest-bearing liabilities

  10,494        9,580        13,826           10,733         

Total Liabilities

  704,247        664,082        836,383           713,196         

Stockholders' Equity

  59,311        55,837        85,106           59,932         

Total Liabilities and Stockholders' Equity

 $763,558       $719,919       $921,489          $773,128         

Net interest income

    $18,332       $16,462        $7,062          $6,190     
                                          

Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)

        3.25%        3.10%          2.99%          3.19%
                                          

Net interest margin (net interest income as a percentage of average interest-earning assets)

        3.43%        3.28%          3.27%          3.39%

 

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Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

 

(Dollar amounts in thousands)

 

Nine months ended September 30,

 

Three Months Ended September 30,

 
 

2018 versus 2017

 

2019 versus 2018

 
 

Increase (Decrease) due to

 

Increase (Decrease) due to

 
 

Volume

 

Rate

 

Total

 

Volume

  

Rate

  

Total

 

Interest income:

                     

Loans

 $1,466 $745 $2,211 $1,181  $307  $1,488 

Securities

  (21)  48  27  27   25   52 

Interest-earning deposits with banks

  4  73  77  123   16   139 

Federal bank stocks

  (16)  58  42  22   17   39 

Total interest-earning assets

  1,433  924  2,357  1,353   365   1,718 
            

Interest expense:

                     

Interest-bearing deposits

  299  702  1,001  205   550   755 

Borrowed funds, short-term

  (59)  57  (2)     (4)  (4)

Borrowed funds, long-term

  (363)  (149)  (512)  90   5   95 

Total interest-bearing liabilities

  (123)  610  487  295   551   846 

Net interest income

 $1,556 $314 $1,870 $1,058  $(186) $872 


Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

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Information pertaining to the allowance for loan losses and nonperforming assets for the three months ended September 30, 2019 and 2018 is as follows:

(Dollar amounts in thousands)

 

As of or for the three months ended

  

September 30,

  

2019

 

2018

Balance at the beginning of the period

 $6,580  $6,118 

Provision for (recovery of) loan losses

  (145)  300 

Charge-offs

  (69)  (76)

Recoveries

  143   18 

Balance at the end of the period

 $6,509  $6,360 
         

Nonperforming loans

 $4,977  $5,488 

Nonperforming assets

  5,458   6,088 

Nonperforming loans to total loans

  0.72%  0.92%

Nonperforming assets to total assets

  0.58%  0.79%

Allowance for loan losses to total loans

  0.94%  1.06%

Allowance for loan losses to nonperforming loans

  130.78%  115.89%

Nonperforming loans decreased $1.0 million, or 17.0% to $5.0 million at September 30, 2019 from $6.0 million at  June 30, 2019. This was primarily due to changes in the non-accrual status of five loans.  Three loans totaling $525,000 were removed from non-accrual status after the application of payments to past due balances brought the loans current.  Additionally, one $423,000 residential real estate loan previously on non-accrual was paid in full and one $91,000 non-accrual residential real estate loan was transferred to OREO.

As of September 30, 2019, the Corporation’s classified and criticized assets amounted to $20.8 million, or 2.2% of total assets, with $17.2 million classified as substandard and $3.6 million identified as special mention. This compares to classified and criticized assets of $25.5 million, or 2.8% of total assets, with $19.8 million classified as substandard and $5.7 million identified as special mention at June 30, 2019. This $4.7 million decrease was primarily related to a $2.5 million payoff of a commercial relationship previously identified as substandard and the upgrade of a $2.1 million commercial relationship from special mention to pass during the third quarter of 2019.

The provision for loan losses decreased $445,000 to a recovery of $145,000 for the three months ended September 30, 2019 from a provision of $300,000 for the same period in 2018. This recovery was primarily due to the aforementioned improvement in the criticized and classified loan balances during the three months ended September 30, 2019.

Noninterest income.  Noninterest income increased $147,000, or 13.8%, to $1.2 million for the three months ended September 30, 2019, compared to $1.1 million for the same period in 2018 due to increases in gains of the sale of securities, gains on the sale of loans and other income of $44,000, $42,000 and $67,000 respectively.  The increase in other income was primarily driven by increases in ATM fees.

Noninterest expense.  Noninterest expense increased $203,000, or 3.4%, to $5.8 million for the three months ended September 30, 2019 from $5.6 million for the same period in 2018.  The increase primarily related to increases in compensation and benefits expense and other noninterest expense of $668,000 and $229,000, respectively, partially offset by a reduction in acquistion costs and FDIC insurance expense of $677,000 and $103,000, respectively.   The increases primarily related to costs associated with the new banking offices acquired in the Community First acquisition and normal salary and benefit and operating expense increases.  The decrease in FDIC insurance expense was a result of utilizing Small Bank assessment credits of $112,000 during the period.

Provision for income taxes. The provision for income taxes increased $257,000 to $444,000 for the three months ended September 30, 2019 compared to $187,000 for the same period in the prior year as a result of the increase in net income before provision for income taxes.

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Comparison of Results for the Nine Months Ended September 30, 2019 and 2018

General. Net income available to common stockholders increased $2.4 million, or 60.1%, to $6.3 million for the nine months ended September 30, 2019 from $3.9 million for the same period in 2018. This increase was the result of increases in net interest income and noninterest income of $3.1 million and $388,000, respectively, and a decrease of $675,000 in the provision for loan losses, partially offset by increases in noninterest expense, provision for income taxes and preferred stock dividends of $1.1 million, $637,000 and $91,000, respectively.

Net interest income. Tax equivalent net interest income increased $3.1 million, or 17.1%, to $21.5 million for the nine months ended September 30, 2019 from $18.3 million for the nine months ended September 30, 2018. This increase was attributed to an increase in tax equivalent interest income of $5.2 million, partially offset by an increase in interest expense of $2.1 million.

Interest income. Tax equivalent interest income increased $5.2 million, or 23.7%, to $27.3 million for the nine months ended September 30, 2019 from $22.0 million for the same period in 2018. This increase was attributed to increases in interest earned on loans, interest on deposits with banks, and securities and dividends on federal bank stocks of $4.8 million, $169,000, $145,000 and $95,000, respectively.
Tax equivalent interest earned on loans receivable increased $4.8 million, or 24.4%, to $24.6 million for the nine months ended September 30, 2019 compared to $19.8 million for the same period in 2018. This increase resulted from a $111.6 million, or 18.9%, increase in average loans, accounting for an increase of $3.9 million in interest income. The increase in loans receivable was related to the acquisition of Community First Bancorp, Inc. in October 2018. Adding to this favorable volume variance, the average yield on loans increased 21 basis points to 4.69% for the nine months ended September 30, 2019, versus 4.48% for the same period in 2018. This favorable yield variance accounted for a $941,000 increase in interest income. Accretion of purchase accounting adjustments on acquired loans accounted for approximately 5 basis points of the yield increase.

Interest earned on deposits with banks increased $169,000, or 74.1%, to $397,000 for the nine months ended September 30, 2019 compared to $228,000 for the nine months ended September 30, 2018. This increase resulted from an $8.5 million increase in the average balance of interest-earning deposits accounting for an increase of $108,000 in interest income. Additionally, a 34 basis point increase in the average yield on these accounts to 1.81% for the nine months ended September 30, 2019, versus 1.47% for the same period in 2018, accounting for a $61,000 increase in interest income.
Tax equivalent interest earned on securities increased $145,000, or 8.0%, to $2.0 million for the nine months ended September 30, 2019 compared to $1.8 million for the nine months ended September 30, 2018. This increase resulted from a 18 basis point increase in the average yield on securities to 2.62% for the nine months ended September 30, 2019 versus 2.44% for the same period in 2018. This favorable yield variance accounted for a $129,000 increase in interest income. Additionally, the average balance of securities increased $841,000 accounting for a $16,000 increase in interest income.

Dividends on federal bank stocks increased $95,000, or 43.0%, to $316,000 for the nine months ended September 30, 2019 from $221,000 for the same period in 2018. This increase was primarily due to a $1.4 million, or 31.3%, increase in the average balance of federal bank stocks, accounting for a $74,000 increase in interest income.  Furthermore, an increase of 56 basis points in the average yield on federal bank stocks to 7.20% for the nine months ended September 30, 2019, versus 6.64% for the same period in 2018, accounted for a $21,000 increase in interest income.

Interest expense. Interest expense increased $2.1 million, or 56.4%, to $5.8 million for the nine months ended September 30, 2019 from $3.7 million for the same period in 2018. This increase in interest expense can be attributed to a $1.8 million increase in interest incurred on deposits and an increase of $329,000 in interest incurred on borrowed funds.

Interest expense incurred on deposits increased $1.8 million, or 54.0%, to $5.0 million for the nine months ended September 30, 2019 compared to $3.3 million for the same period in 2018. The average cost of interest-bearing deposits increased 28 basis points to 1.09% for the nine months ended September 30, 2019, versus 0.81% for the same period in 2018, accounting for a $1.3 million increase in interest expense. Additionally, the average balance of interest-bearing deposits increased $75.1 million, or 13.8%, to $618.8 million for the nine months ended September 30, 2019, compared to $543.7 million for the same period in 2018 causing a $498,000 increase in interest expense. This increase was primarily due to the acquisition of Community First in October 2018.

Interest expense incurred on borrowed funds increased $329,000, or 74.8%, to $769,000 for the nine months ended September 30, 2019, compared to $440,000 for the same period in the prior year. The average balance of borrowed funds increased $16.1 million, or 74.8%, to $37.5 million for the nine months ended September 30, 2019, compared to $21.5 million for the same period in 2018 causing a $335,000 increase in interest expense. The increase in the outstanding balance of borrowed funds primarily resulted from three additional $5.0 million FHLB long-term notes taken in December 2018. Additionally, the average cost of long-term borrowed funds increased 11 basis points to 2.56% for the nine months ended September 30, 2019 compared to 2.45% for the same period in 2018 causing a $16,000 increase in interest expense.  Partially offsetting these increases, the average cost of short-term borrowed funds decreased 86 basis points to 3.78% for the nine months ended September 30, 2019  compared to 4.64% for the same period in 2018 causing a $22,000 decrease in interest expense.

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Table of Contents

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

(Dollar amounts in thousands)

 

Nine Months Ended September 30,

 
  

2019

  

2018

 
  

Average

      

Yield/

  

Average

      

Yield/

 
  

Balance

  

Interest

  

Rate

  

Balance

  

Interest

  

Rate

 

Interest-earning assets:

                        

Loans, taxable

 $681,235  $24,002   4.71% $569,745  $19,223   4.51%

Loans, tax exempt

  20,770   609   3.92%  20,661   568   3.68%

Total loans receivable

  702,005   24,611   4.69%  590,406   19,791   4.48%

Securities, taxable

  82,335   1,606   2.61%  73,705   1,312   2.38%

Securities, tax exempt

  17,450   348   2.67%  25,239   497   2.63%

Total securities

  99,785   1,954   2.62%  98,944   1,809   2.44%

Interest-earning deposits with banks

  29,294   397   1.81%  20,763   228   1.47%

Federal bank stocks

  5,860   316   7.20%  4,461   221   6.64%

Total interest-earning cash equivalents

  35,154   713   2.71%  25,224   449   2.38%

Total interest-earning assets

  836,944   27,278   4.36%  714,574   22,049   4.13%

Cash and due from banks

  3,336           2,812         

Other noninterest-earning assets

  62,702           46,172         

Total Assets

 $902,982          $763,558         

Interest-bearing liabilities:

                        

Interest-bearing demand deposits

 $395,464  $1,827   0.62% $373,534  $1,375   0.49%

Time deposits

  223,349   3,218   1.93%  170,151   1,902   1.49%

Total interest-bearing deposits

  618,813   5,045   1.09%  543,685   3,277   0.81%

Borrowed funds, short-term

  5,536   156   3.78%  2,817   98   4.64%

Borrowed funds, long-term

  31,998   613   2.56%  18,661   342   2.45%

Total borrowed funds

  37,534   769   2.74%  21,478   440   2.74%

Total interest-bearing liabilities

  656,347   5,814   1.18%  565,163   3,717   0.88%

Noninterest-bearing demand deposits

  150,096         128,590       

Funding and cost of funds

  806,443   5,814   0.96%  693,753   3,717   0.72%

Other noninterest-bearing liabilities

  13,667           10,494         

Total Liabilities

  820,110           704,247         

Stockholders' Equity

  82,872           59,311         

Total Liabilities and Stockholders' Equity

 $902,982          $763,558         

Net interest income

     $21,464          $18,332     
                         

Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)

          3.17%          3.25%
                         

Net interest margin (net interest income as a percentage of average interest-earning assets)

          3.43%          3.43%

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Table of Contents

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

(Dollar amounts in thousands)

 

Nine Months Ended September 30,

 
  

2019 versus 2018

 
  

Increase (Decrease) due to

 
  

Volume

  

Rate

  

Total

 

Interest income:

            

Loans

 $3,879  $941  $4,820 

Securities

  16   129   145 

Interest-earning deposits with banks

  108   61   169 

Federal bank stocks

  74   21   95 

Total interest-earning assets

  4,077   1,152   5,229 
             

Interest expense:

            

Interest-bearing deposits

  498   1,270   1,768 

Borrowed funds, short-term

  80   (22)  58 

Borrowed funds, long-term

  255   16   271 

Total interest-bearing liabilities

  833   1,264   2,097 

Net interest income

 $3,244  $(112) $3,132 

 

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

 

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Table of Contents

 

Information pertaining to the allowance for loan losses and nonperforming assets for the nine months ended September 30, 20182019 and 20172018 is as follows:

 

(Dollar amounts in thousands)

 

As of or for the nine months

 

As of or for the nine months ended

 
 

September 30,

 

September 30,

 
 

2018

 

2017

 

2019

  

2018

 

Balance at the beginning of the period

 $6,127 $5,545 $6,508  $6,127 

Provision for loan losses

  980  633  305   980 

Charge-offs

  (807)  (275)  (544)  (807)

Recoveries

  60  37  240   60 

Balance at the end of the period

 $6,360 $5,940 $6,509  $6,360 
              

Non-performing loans

 $5,488 $3,731

Non-performing assets

  6,088  4,160

Non-performing loans to total loans

  0.92%  0.64%

Non-performing assets to total assets

  0.79%  0.54%

Nonperforming loans

 $4,977  $5,488 

Nonperforming assets

  5,458   6,088 

Nonperforming loans to total loans

  0.72%  0.92%

Nonperforming assets to total assets

  0.58%  0.79%

Allowance for loan losses to total loans

  1.06%  1.02%  0.94%  1.06%

Allowance for loan losses to non-performing loans

  115.89%  159.21%

Allowance for loan losses to nonperforming loans

  130.78%  115.89%


Nonperforming loans increased $1.8$1.9 million, or 48.6%98.1%, to $5.5$5.0 million at September 30, 20182019 from $3.7$3.0 million at December 31, 2017.2018. This increase was primarily due to a $2.5one commercial relationships totaling $2.4 million commercial mortgage loan being placeplaced on nonaccrualnon-accrual status based onpartially offset by the deteriorating financial conditionpayoff of the borrower. Given the estimated value of the borrower's significantone residential real estate holdings, most of which are pledged as collateral for the loan the Corporation does not currently expect to incur any loss on this loan and the loan continues to pay per its contractual terms. Partially offsetting this increase, a $559,000 commercial mortgage was transferred to OREO and a $789,000 commercial relationship was repaid in fulltotaling $423,000 during the nine months ended September 30, 2018. Of the $5.5 million in nonperforming loans, $3.1 million were not 30 days or more past due at September 30, 2018.2019.

 

As of September 30, 2018,2019, the Corporation’s classified and criticized assets amounted to $14.5$20.8 million, or 1.9%2.2% of total assets, with $10.6$17.2 million classified as substandard and $3.9$3.6 million identified as special mention. This compares to classified and criticized assets of $14.8$22.9 million, or 2.0%2.5% of total assets, with $11.6$16.4 million classified as substandard and $3.2$6.5 million identified as special mention at December 31, 2017.2018. This decrease was primarily related to the risk rating upgrade of one $1.9 million commercial loan relationship, the payoffupgrades of two commercial loan relationships totaling $1.1$2.4 million, the payoffs of five commercial relationships totaling $1.9 million, the $423,000 payoff of a residential real estate loan and the aforementioned $559,000 loan transferredtransfer to OREO. These favorable changes to the Corporation's classified and criticized assets wereOREO of one commercial relationship totaling $232,000,  partially offset by the risk rating downgrades of threefive commercial loan relationships to special mention and substandard.totaling $3.4 million.

 

The provision for loan losses increased $347,000,decreased $675,000, or 54.8%68.9%, to $980,000$305,000 for the nine months ended September 30, 20182019 from $633,000$980,000 for the same period in 2017 due primarily2018 as criticized and classified loans improved by $2.1 million and portfolio net charge-offs were lower compared to general growththe same period in the loan portfolio and certain charge-offs experienced during the first nine months of 2018.

Noninterest income.  Noninterest income decreased $987,000,increased $388,000, or 24.7%12.9%, to $3.0$3.4 million for the nine months ended September 30, 2018 from $4.02019, compared to $3.0 million for the same period in 2017. During2018. Fees and service charges increased $194,000, primarily associated with the operation of the three new full-service banking offices which were acquired from Community First and general increases in overdraft fee income. Additionally, net gains on the sale of loans and net gains on the sale of securities increased $69,000 and $52,000, respectively.

Noninterest expense.  Noninterest expense increased $1.1 million, or 7.2%, to $16.6 million for the nine months ended September 30, 2017,2019 from $15.5 million for the Corporation recorded a $1.3 million bargain purchase gainsame period in 2018.  The increase primarily related to increases in compensation and benefits expense, other noninterest expense and occupancy and equipment expense of $1.4 million, $718,000 and $272,000, respectively.  The increases primarily related to costs associated with the aforementioned new banking offices and normal salary and benefit and operating expense increases.  These increases in noninterest expense were partially offset by a decreases of $1.0 million in acquisition costs and $124,000 in FDIC insurance expense.  The decrease in FDIC insurance expense was a result of NHBT. Alsoutilizing Small Bank assessment credits of $112,000 during the period.

Provision for income taxes. The provision for income taxes increased $637,000, or 86.7%, to $1.4 million for the nine months ended September 30, 2017, the Corporation recorded a $508,000 other-than-temporary impairment charge on a subordinated debt investment issued by First NBC Bank Holding Company. Partially offsetting the impairment charge, the Corporation realized security gains of $350,000 during the nine months ended September 30, 2017. During the nine months ended September 30, 2018, the Corporation realized security losses of $34,000. Additionally, fees and service charges increased $138,000 as overdraft charges2019 compared to $735,000 for the nine months ended September 30, 2018 outpaced the same period in the prior year and other income increased $168,000 due to increased interchange fee income and fair value adjustments related to the Corporation's equity securities. Partially offsetting these favorable items, gains on the sales of loans totaled $60,000 for the nine months ended September 30, 2018, compared to $176,000 for the same period in 2017.

Noninterest expense. Noninterest expense increased $796,000, or 5.4%, to $15.5 million for the nine months ended September 30, 2018 compared to $14.7 million for the same period in 2017. This increase in noninterest expense can be attributed to increases in compensation and benefits and professional fees of $536,000 and $137,000, respectively.

Compensation and employee benefits increased $536,000, or 7.7%, to $7.5 million for the nine months ended September 30, 2018 compared to $7.0 million for the same period in 2017. This increase was primarily theas a result of increases in salaries, insurance benefits and stock compensation expense of $341,000, $91,000 and $22,000, respectively. These increases are primarily related to costs associated with the operation of the new full-service banking office in Chester, West Virginia which was acquired from Northern Hancock, increased health insurance costs and normal salary and benefit increases.

Professional fees costs increased $137,000, or 23.8%, to $712,000 for the nine months ended September 30, 2018 compared to $575,000 for the same period in 2017. The increase was primarily the result of additional consulting agreements added during 2018.

Provision for income taxes. The provision for income taxes decreased $243,000, or 24.9%, to $735,000 for the nine months ended September 30, 2018 compared to $978,000 for the same period in the prior year. This related to an decrease in the Corporation’s effective tax rate to 15.7% for the nine months ended September 30, 2018 compared to 20.9% for the same period in 2017, partially offset by an increase in net income before provision for income taxes. The decrease in the Corporation's effective tax rate was due to the enactment of the Tax Cuts and Job Act in December 2017 and the reduction of the corporate income tax rate from a maximum of 35% to a flat 21%.

 


LIQUIDITY

 

The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB, Federal Reserve and other correspondent banks, and amortization and prepayments of outstanding loans and maturing securities. During the nine months ended September 30, 2018,2019, the Corporation used its sources of funds primarily to fund loan advancesreduce short-term borrowed funds and repay long-term borrowed funds.increase interest earning time deposits and investment balances. As of September 30, 2018,2019, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $99.9$107.4 million, and standby letters of credit totaling $96,000,$979,000, net of collateral maintained by the Bank.

 

At September 30, 2018,2019, time deposits amounted to $169.4$227.2 million, or 24.9%28.1% of the Corporation’s total consolidated deposits, including approximately $44.0$64.2 million of which are scheduled to mature within the next year. Management of the Corporation believes (i) it has adequate resources to fund all of its commitments, (ii) all of its commitments will be funded as required by related maturity dates and (iii) based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities if necessary.

 

Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation and the Bank have alternative sources of funds. These sources include a line of credit for the Corporation with a correspondent bank, the Bank's line of credit and term borrowing capacity from the FHLB and the Federal Reserve’s discount window and, to a more limited extent, through the sale of loans. At September 30, 2018,2019, the Corporation had borrowed funds of $19.8$33.8 million consisting of $15.0$30.0 million of long-term FHLB advances, a $2.8$1.7 million long-term advance with a correspondent bank and $2.1 million outstanding on a line of credit with a correspondent bank. At September 30, 2018,2019, the Corporation’s borrowing capacity with the FHLB, net of funds borrowed and irrevocable standby letters of credit issue to secure certain deposit accounts, was $191.6$250.1 million.

 

Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business.

 

RECENT REGULATORY DEVELOPMENTS

 

The final rules implementing the Basel Committee on Banking Supervision’s (BCBS) capital guidelines for U.S. banks were approved by the FRB and FDIC. Under the final rules, minimum requirements increased for both the quantity and quality of capital. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0% and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer comprised of common equity Tier 1 capital was also established above the regulatory minimum capital requirements. This capital conservation buffer was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and will increasehas increased each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital and risk-weighted assets. The phase-in period for the final rules became effective on January 1, 2015 with full compliance with all of the final rules’ requirements phased in over a multi-year schedule to bewhich was fully phased-in byon January 1, 2019.

 

At September 30, 2018,2019, the Bank exceeded all minimum capital requirements under these capital guidelines.

 

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CRITICAL ACCOUNTING POLICIES

 

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily though the use of internal cash flow modeling techniques.

 

The most significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017.2018. These policies, along with the disclosures presented in the other financial statement notes provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the following as critical accounting policies.

 

Allowance for loan losses. The Corporation considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. Among the many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact the Corporation’s financial condition or earnings in future periods.

 

Other-than-temporary impairment. Management evaluates debt securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.

 

Goodwill and intangible assets. Goodwill represents the excess cost over fair value of assets acquired in a business combination. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. The impairment test is a two-step process that begins with an initial impairment evaluation. If the initial evaluation suggests that an impairment of the asset value exists, the second step is to determine the amount of the impairment. If the tests conclude that goodwill is impaired, the carrying value is adjusted and an impairment charge is recorded. As of November 30, 2017, the required annual impairment test of goodwill was performed and management concluded that no impairment existed as of that date. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values. Goodwill is subject to ongoing periodic impairment tests based on the fair value of the reporting unit compared to its carrying amount, including goodwill. Impairment exists when a reporting unit’s carrying amount exceeds its fair value. At November 30, 2018, the required annual impairment test of goodwill was performed and no impairment existed as of the valuation date. If for any future period it is determined that there has been impairment in the carrying value of our goodwill balances, the Corporation will record a charge to earnings, which could have a material adverse effect on net income, but not risk based capital ratios.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and interest-bearing liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Bank does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets and interest-bearing liabilities. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses depend upon the local economic conditions in the immediate trade area.

 

One of the primary functions of the Corporation’s asset/liability management committee is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability committee is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates.

 

Interest rate sensitivity is the result of differences in the amounts and repricing dates of the Bank’s rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing “gap”, provide an indication of the extent that the Corporation’s net interest income is affected by future changes in interest rates. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

 

Assumptions about the timing and variability of cash flows are critical in gap analysis. Particularly important are the assumptions driving mortgage prepayments and the expected attrition of the core deposits portfolios. These assumptions are based on the Corporation’s historical experience, industry standards and assumptions provided by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation’s assets and liabilities to interest rate changes. As of September 30, 2018,2019, the Corporation’s interest-earning assets maturing or repricing within one year totaled $177.0$270.6 million while the Corporation’s interest-bearing liabilities maturing or repricing within one-year totaled $155.5$196.0 million, providing an excess of interest-earning assets over interest-bearing liabilities of $21.5million.$74.6 million. At September 30, 2018,2019, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 113.8%138.1%.

 

For more information, see “Market Risk Management” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017.2018.

 

Item 4. Controls and Procedures

 

The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e).

 

As of September 30, 2018,2019, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s CEO and CFO, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on the foregoing, the Corporation’s CEO and CFO concluded that the Corporation’s disclosure controls and procedures were effective. There have been no significant changes in the Corporation’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Corporation completed its evaluation.

 

There has been no change made in the Corporation’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Corporation is involved in various legal proceedings occurring in the ordinary course of business. It is the opinion of management, after consultation with legal counsel, that these matters will not materially affect the Corporation’s consolidated financial position or results of operations.

 

Item 1A. Risk Factors

 

Not applicable.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

(a)

Not applicable.

 

(b)

Not applicable.

 

Item 6. Exhibits

 

Exhibit 31.1

Rule 13a-14(a) Certification of Principal Executive Officer

Exhibit 31.2

Rule 13a-14(a) Certification of Principal Financial Officer

Exhibit 32.1

CEO Certification Pursuant to 18 U.S.C. Section 1350

Exhibit 32.2

CFO Certification Pursuant to 18 U.S.C. Section 1350

101.INS

XBRL Instance Document

101.SCH

XBRL Taxonomy Extension Schema Document

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

XBRL Taxonomy Extension Definitions Linkbase Document

101.LAB

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

 

EMCLAIRE FINANCIAL CORP

 

 

 

Date: November 9, 20188, 2019

By:

/s/ William C. Marsh

 

William C. Marsh

 

Chairman of the Board,

 

President and Chief Executive Officer

 

 

 

Date: November 9, 20188, 2019

By:

/s/ Amanda L. Engles

 

Amanda L. Engles

 

Chief Financial Officer

 

Treasurer

 

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